Members of five ULI councils discuss prospects for investment and development, including the product types with the most potential, the roles of public/private partnerships and transit-oriented development, and the influence of demographic trends.
Investors around the world are waiting to see if European leaders can fix their lingering debt crisis. Investors’ concerns—and their picks for best markets in 2012—are the focus of this package, which includes a ULI roundtable on development prospects, and a comprehensive report on the ULI/PwC Emerging Trends in Real Estate reports covering the United States, Canada, Europe, and Asia Pacific, based on a survey of more than 1,900 of the world’s top real estate experts.
Contributing their insights are Alan Billingsley, head of Research Americas for RREEF Real Estate in San Francisco and a member of the Commercial & Retail Development Council (Silver Flight); Steven Kohn, president and principal of Cushman & Wakefield Sonnenblick-Goldman LLC, based in New York City, chair of the Urban Development/Mixed Use Council (Red Flight), and a member of the advisory board of ULI New York; Keith Locker, CEO and president of Inlet Capital in New York City, chairman of the board of Sunstone Hotel Investors Inc., based in Aliso Viejo, California, and chair of the Commercial & Retail Development Council (Silver Flight); Tyrone Rachal, senior development manager of tax allocation districts at the Atlanta Development Authority and chair of the Public/Private Partnership Council (Gold Flight); John Williams, managing partner, capital markets, of Carmel Partners in San Francisco and chair of the Multi-Family Council (Silver Flight); and David Winstead, an attorney with the real estate and infrastructure/P3 departments at Ballard Spahr in Washington, D.C., chair of ULI’s Public Development Infrastructure Council, and former U.S. public buildings commissioner.
Given the ongoing economic uncertainty, what do you expect in the coming years in your sector?
Steven Kohn: Right now, interest rates are extremely low, so the cost of capital is low and investing in real estate looks more attractive than certain fixed-income investments. The stock market has been volatile, so real estate looks more stable in comparison to equities. The negative impact of economic uncertainty is not being able to project significant rental growth in many markets until we see a recovery in the job market. This is why many institutions acquire core properties that are not as dependent on lease-up and substantial rental growth to provide adequate returns. They want stable assets that offer a relatively attractive spread over the Treasury rate. But for investors that are more interested in value-add properties, there aren’t as many opportunities.
Keith Locker: Retail management teams are seeing pretty good fundamentals in their portfolios, especially in the higher-end malls, as well the grocer- and food-and-drug-anchored centers. They are not as concerned with tenant bankruptcies and other disruptions at the asset level as they were at the start of the recession. The office sector is much more dependent on job formation, and with the economic uncertainty and a cloudy picture on job growth, the office sector is more slow paced. The exceptions, of course, are in New York, San Francisco, and some of the CBD [central business district] coastal markets; they have withstood the downturn much better.
Alan Billingsley: Vacancy rates in shopping centers are still elevated and likely to remain high. The better retailers, like Bed Bath & Beyond, Best Buy, and Staples, are going to try to move into the best possible centers in each market, if they aren’t already there. They may pay more to get into those centers, and they may close a couple of stores in lesser-quality centers nearby, leaving those centers in an even worse position. The luxury retail centers, which include malls, are doing very well.
John Williams: Multifamily for-rent housing is probably the strongest sector in the United States. There’s much more interest in infill development projects in urban areas that might have some transit-oriented aspect or sustainability aspect. That interest is coming from the developer side, the tenant side, and the city planning side.
Tyrone Rachal: The tone at the ULI Fall Meeting was one of optimism. Most of the respondents on the Public/Private Development Council—which includes elected officials, heads of redevelopment authorities, and representatives from state educational systems, as well as developers and other private sector service providers—see a definite economic recovery. In the coming years, significant real estate development projects that have job-creation components will become increasingly dependent upon public/private partnerships. The new markets tax credit (NMTC) program has become very popular in the private sector.
David Winstead: The public sector is suffering from severe budget pressures, and many government agencies are looking at ways to design space to accommodate more people per square foot and at consolidating existing leases and extensions. Federal and state agencies are trying to leverage public/private sector partnerships rather than wait for traditional appropriated funds to move projects forward. There is more willingness to consider leasing/construct options, as well as exchange, ground lease, and leaseback arrangements. With interest rates so low, there’s not a huge difference between the cost of a federally appropriated and constructed project versus a lease approach.
What asset classes are attracting investor interest?
Rachal: Capital, particularly construction debt, is opening up for multifamily projects. That’s true across the country. In Atlanta, interestingly enough, the hottest deals that I have in my pipeline for new markets tax credits are medical office building projects. That’s partly because the NMTC program’s mission is to provide tangible benefits to low-income communities, and what better way to do that than to finance medical office buildings in those communities? We are also seeing a huge demand for financing charter school facilities with new markets tax credits, and those are some of the easiest deals to get investors interested in. They also often attract other development projects around them.
Kohn: Multifamily housing is performing well in part because there has been a shift from buying to renting. Investors also benefit from very attractive financing for this sector. Certain types of retail are still in high demand, such as grocery-anchored shopping centers, dominant malls, and urban retail properties. Investor demand for office property is strong in certain markets, such as New York, Washington, D.C., and San Francisco, but weaker in many secondary markets. In the office and retail sectors, one very positive impact on future value and investor interest is that there is little new construction, so competition from future supply is less of a concern. Health care assets benefit from our aging baby boomers and limited new supply. Hotels are highly dependent on corporate travel budgets, and, in certain markets, on tourists from countries with strong currencies. Many investors feel this is a great time to acquire hotels at well below replacement cost.
What kinds of opportunities are there for acquiring distressed assets?
Williams: Multifamily housing is in pretty good shape. Everyone thinks there are distressed assets, but there are not a lot; the multifamily housing sector has a lot of liquidity. It’s cheaper and more expeditious for lending institutions to work out a deal with a borrower than to go through foreclosure on a property and sell it. So unless they have a significantly problematic borrower, lenders will do what they can to work it out. If there is a distressed project, it’s in trouble for a reason.
Locker: There is a mirage of distressed properties. You know they are there, you can see them, but it’s very difficult to find that fulcrum position and get possession of a distressed asset. But with a number of five-year floating-rate loans coming due this year and next, there is going to be a shortfall in the capital required to refinance many of those loans, and that’s where we see a great deal of opportunities to provide that capital. In the stronger markets, however, there is a lot of competition over some of these distressed assets, which has made acquiring them a challenge.
Given the economic strain on government budgets, what do the prospects look like for transit-oriented development?
Winstead: The U.S. Department of Transportation and the Federal Transit Administration are continuing to encourage higher-density development at transit nodal points, and that’s being reinforced by the U.S. Department of Housing and Urban Development under affordable housing incentive programs and by the U.S. Environmental Protection Agency, which is advocating for more sustainable development. So even though fewer funds are coming out of the transportation trust funds and the federal building fund, most of the future development from those sources will continue to focus on transit-oriented sites. A great example is the planned rapid transit improvements and high-density mixed-use development that has been approved for the White Flint corridor in the metropolitan Washington region.
Rachal: As the public sector starts to invest in our aging infrastructure, that presents opportunities for transit-oriented development. With more density, developers can spread their capital across a greater number of units and make their pro formas work. So transit-oriented development investments are not going to go away. With the Atlanta Beltline, the largest infrastructure project in the Southeast, we’re already seeing investor capital going to development sites nearby in anticipation. In addition, we’re just starting to build a multimodal passenger terminal in [Atlanta’s] core. Even before that terminal is constructed, we expect to see a lot of private sector interest in TODs around that site.
How will demographic changes affect your sector?
Billingsley: In the next decade, generation Y is going to be the dominant force in retail growth, and they are very internet savvy. There is still a strong role for bricks-and-mortar retail, but the retailers are expecting more sales to take place via the internet. So they are continuing to downsize their formats, and more importantly, they are going to have fewer stores. Stores will act more like showrooms, where consumers can try on or feel merchandise. Also, members of generation X are now in their 30s and 40s. That age range has historically been the key cohort for retail sales because they are in their family creation period. But that’s a reduced population now, so retailers that target that age segment are going to have to be careful.
Williams: Members of generation Y are more used to living in urban areas than preceding generations. They don’t want to have to drive 20 minutes from home to get a gallon of milk; they want to live in a dynamic neighborhood close to their friends, to work, and to places where they can socialize. They will pay a premium for that, and they can afford to if they don’t need a car. For example, in the Bay Area, Google and Genentech have such a high proportion of young employees who want to live in the San Francisco area that they have organized their own transportation system to drive them down to Mountain View.
What other trends will be shaping investment and development in the next few years?
Locker: The market is much more sophisticated than it used to be, and the increase of public ownership and the role of the REITs [real estate investment trusts] have led to a great deal of transparency and information flow relating to real estate. So it has become a very efficient market, which means we’re not seeing the widespread opportunities that we did, say, in the Resolution Trust Corporation days 20 years ago. Offsetting that is the complexity and the amount of stratification of the capital structure of an asset these days—for example, the role of the special servicer and the trust structure of the mortgage market. Those complex and stratified capital structures make dealing with the challenges of today more difficult.
Kohn: We are seeing more equity invested in real estate than we have in a long time, which will stabilize ownership of assets for years to come. We are also seeing more cross-border capital flows coming from parts of Asia (China, South Korea), the Middle East (Kuwait, Israel, Abu Dhabi, Qatar), some from Mexico and South America, and a lot from Canada. Canada’s financial institutions fared relatively well over the last few years, so the banks, insurance companies, and pension funds have been very active investors in the United States.
Winstead: Although governments will be trying to stimulate economic development through government facility and real estate demands, tools such as tax increment financing, transportation improvement districts, and development district taxes will be increasingly utilized to generate transportation funding for private sector growth, which will add to the economy by increasing the value of commercial development and resulting tax revenues. Many of the most recent larger General Services Administration lease deals were added by underwriting the donation of the property or providing some kind of economic development incentive.
Williams: Multifamily housing will be smaller. We won’t have behemoths that are out at the last exit off the freeway. Units will be smaller and more efficient, and they may not have as much parking. It used to be that a typical project had 1.5 to 1.7 parking spots per unit, but in the future the parking ratio will probably be 1 to 1 or even less than that. There won’t be as many on-site amenities. Instead, multifamily housing owners will emphasize amenities in the neighborhood—proximity to great restaurants, transportation, entertainment, workplaces.
Billingsley: I don’t expect a lot of retail development for a few years. Retail is going to be slow to come back because there is such an excess of it, and retailers are going to be much more careful about expansion. But at the same time, as we get more into the recovery, I think we’re going to see an explosion of new retailing concepts, both by existing national retailers and new private companies. There haven’t been any new retailing concepts for the last four or five years, so I think that there is pent-up tenant demand. And because there is so much demand for new multifamily housing, there will be opportunities for ground-floor retail in apartment buildings.