Archives for March 2015

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2014 was a breakout year for the economy and the rental market where we saw record occupancy rates and a rise in residential development. But will this rental housing boom continue through 2015? We’ll cover the answer to this question and more in this essential forecast from Senior Economist, Ryan Severino. Property management professionals will not want to miss these insights on the economic trends that matter most to your business.

Register to learn more about:

• The relationship between interest rates and cap rates
• Find out if strong demand for apartments will persist
• The impact of rising construction on the residential housing market
• Will the homeownership rate keep falling?
• And so much more!

What does it mean for corporate commercial real estate users?
Long before brokers, investors, and other commercial real estate professionals embraced smartphones and tablets, commercial real estate was a data-driven business, even if many of us didn’t realize it. Successful professionals in our industry have always been masterful networkers and information-gatherers, with encyclopedic knowledge of market conditions. Today, this mastery of data and analytics has earned a place of even greater importance and is becoming the tool of choice for gaining a competitive edge.
What’s Fueling the Data Fire?
Technological advances have increased the capacity — and lowered the cost — of data and analytics platforms that enable quick data aggregation and new ways to create real-time analyses and scenarios for commercial real estate decisions. Advanced Web platforms, cloud computing, and new storage technologies are speeding up the data and analytics evolution, making it cheaper and faster than ever before to acquire and interpret the data.
And it’s not just numbers, anymore. Today’s business intelligence platforms can include “unstructured” data that doesn’t fit neatly into a spreadsheet, such as emails, social media posts, images, transaction logs, and other kinds of non-numerical information — even social media-sharing figures.
The result is better-informed site selection, transaction negotiations, workplace design, and facilities management, along with a competitive advantage for the clients of data-focused commercial property owners, investors, asset and property managers, and brokers.
The Tenant Perspective
The increasingly sophisticated use of analytics across various business activities has led to powerful shifts in how companies make decisions, innovate, and strategize. In a 2014 study by Sloan School of Management at the Massachusetts Institute of Technology, 66 percent of executives reported a gain in competitive advantage derived from data and analytics, up from 37 percent in 2010. Similarly, a Harvard Business Review study found that companies in the top third in their industries with regard to data-driven decision-making are 5 percent more productive and 6 percent more profitable than their competitors.
Unlike the consumer products sector where intensive data and analytics have long been used for consumer segmentation and marketing, the commercial real estate industry has been relatively slow to invest in data management and analytics software. True, such companies as Yardi and Real Capital Analytics have been established providers of commercial real estate data for many years. Also, some of the largest commercial real estate investment companies have created their own proprietary databases and software for their own reporting needs. However, many commercial real estate practitioners — even at large companies — continue to rely on spreadsheets and manual analyses.
Where Data Gives the Competitive Edge
The following are some of the major ways data and analytics are propelling the transformation the business of commercial real estate.
Complex Comparables. Companies such as LoopNet, Real Capital Analytics, Reis Inc., and Compstak were among the first to see the potential for automating database functions for commercial property brokers and investors, providing everything from recent transaction prices and capitalization rates to concessions and operating expenses in thousands of markets. Rather than leading to the demise of commercial property brokers, today’s new analytics platforms enable data-focused brokers to provide nuanced insights about long-term value, risks, the true costs of a particular transaction, and more.
Sophisticated Site Selection. Consider a third-party logistics company that is expanding its distribution center network. It needs to know which makes more sense, paying more for a premium site close to customers or a lower-cost location on the outskirts of the market.
With data and analytics tools, you can compile such factors as macroeconomic trends, real estate costs, transportation channels, dock access, and workforce availability into sophisticated risk and return-on-investment analyses. These inputs can help a company locate operations where the labor availability and real estate options will support broad business goals such as speed-to-market and workforce expertise — in addition to keeping costs under control.
Workplaces That Actually Work. Real estate shapes the working environment and can tell you a lot about key corporate priorities such as employee engagement and innovation potential. It can also tell you what employees don’t report, such as where the best work actually gets done.
To inform site selection and facilities decisions, a company can use data and analytics to determine how and where employees are working — and why. For example, sensor logs and mapping tools can reveal when and for how long employees are using a particular space. Real-time monitoring of space utilization can help companies optimize their real estate footprint, tailor services to employees, and design spaces that match work patterns, thereby improving overall productivity.

In one classic example, a global pharmaceutical company used data and analytics to reduce its real estate and facilities costs by $200 million over the course of three years while improving productivity. Aggregating more than 100,000 portfolio and business data points with on-the-ground market intelligence, the corporate real estate team used analytics, automated financial modeling, and scenario tools to determine which facilities were the least productive or non-strategic. With robust data to guide its facility consolidations and disposition decisions, the team achieved its aggressive savings goal and freed up additional capital to invest in research and development.
Expedited Transactions and Move-ins. Site selection expertise can be combined with virtual tour technologies that not only provide remote site visits, but also provide tracking metrics. An analysis of how clients are using virtual tours — which videos, for how long, and by whom — can help brokers predict how many tours will lead to a successful deal, and how to improve the “hit” rate. Then, occupancy and workplace strategy data can be used to create various move-in scenarios to optimize workplace productivity.
Smart Data, Smarter Buildings. Today’s increasingly informed clients and investors want hard data like long-term energy costs and operating performance. Advanced smart building management technologies make it possible to obtain this data and more. New building technologies offer tremendous energy-savings potential derived from the data generated by today’s computer-controlled “smart” systems, and a data-savvy management team can prevent costly and disruptive equipment failure, optimize building performance, and manage resources across a huge property portfolio with a single highly efficient dashboard. Combined with financial and legal inputs, this portfolio performance data becomes an invaluable tool for long-term strategic planning.
Is Your Team Data-Centric?
Inside corporate real estate departments, companies have begun investing more heavily in data and analytics platforms. Data-centricity is quickly becoming the strategic vision of choice among corporate real estate and site selection executives, according to Mind the Gap: Aspiration vs. Reality in Corporate Real Estate, a new Forrester Consulting survey commissioned by JLL.
More than half of corporate real estate leaders say they aim to become data-centric by 2017 — that is, using corporate real estate data not just to support opinions or decisions, but also to actually shape opinions and corporate strategy. Sixty-four percent of corporate real estate teams experienced an increase in their data and analytics budgets in the last fiscal year and expect a budget increase this year, too, according to the study.
These in-house leaders are using data-driven business intelligence and analytics to, for instance, determine which facilities are most productive in terms of revenue generation, or which sites are most appealing to critical talent pools. Some are using complex mapping tools to visualize data relating to hundreds of sites around the world and quickly determine the best strategies for optimizing the corporate real estate footprint.
The clear rise in the use of big data and analytics technologies is transforming the commercial real estate industry, and the evolution has just begun. Rather than detracting from the very human skills required for managing people, transactions, properties, and portfolios, data and analytics are bringing faster and better-informed decision-making capabilities to all parties in the commercial real estate sector.
By: David Kollmorgen (Commercial Investment Real Estate)

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Everyone in real estate knows how to calculate a cap rate – or do they?
Commercial real estate professionals live and breathe capitalization rates. Every trade publication, market participant, and third-party report relating to real estate quotes cap rates for various markets and properties. But ask a group of real estate professionals to calculate a specific property’s cap rate and you are likely to get a variety of answers — despite the simplicity of the formula. If cap rates are widely used and easily calculated, then why does everyone come up with a different answer?
Learn more about cap rates in CI 101: Financial Analysis for Commercial Investment Real Estate.
This article looks at the underlying reasons for cap rates variations, ranging from different uses by market participants to different methods of cap rate extraction. While CCIMs are trained to extract cap rates in a certain way, not all market professionals use the same criteria. Understanding how such variables can affect the cap rate and the value of a property is just as important as developing — and using — a consistent method of cap rate extraction.
Cap Rate Overview
A cap rate in its simplest form is a return on an investment based on the principle of anticipation. Value is the present worth of future benefits. A cap rate attempts to quantify the risk profile of the future benefits. It is calculated by using a non-complex formula, R=I/V, where I is the net operating income and V is the value of the property. In more complex terms, a cap rate measures a single-period, unleveraged rate of return on a real estate investment. By converting income into value, a cap rate expresses the relationship of one year’s income and value.
A cap rate’s three main components are net income, property value, and the rate of return. If two of the three variables are known, the unknown variable can be extracted through a simple calculation.
Granted, different types of cap rates exist — overall, terminal, equity, mortgage, building, and land — which may cause some confusion among market participants. The overall rate, or OAR, is the cap rate applied to both the land and building and is the most commonly used rate by real estate professionals. A cap rate is essentially a dividend rate, so one could call the mortgage constant a “lender” cap rate and a cash-on-cash an “equity” cap rate.  However, in commercial real estate transactions, brokers and investors tend to focus on two cap rates: acquisition and disposition.
Marketplace Misuse?
Common reasons for cap rate variations often come from the income stream and operating expenses used in the rate’s extraction. Failure to consider the likely future income of the property (year one pro forma) does not follow the principal of anticipation. The historical and current operating data is useful when developing a projection of year one data, but should not be used in the extraction of a cap rate when applying it to year one projections. Extracting a cap rate from market data using historical income and applying it to the year one projection of the property being valued will result in an incorrect value opinion.

Real estate is often considered a hedge against inflation due to the ability to increase rents at or above the rate of inflation. In an upward trending market the buyer of a property is expecting next year’s income (year one) to be greater than the trailing year to account for appreciation. Extracting a cap rate from the in-place income (less risk) and applying it to the future income projection (more risk) will overvalue the property.
In addition, the same method of income and expense projections used to extract a cap rate from the market should be used to value a property. Using a different income stream from a comparable property (not stabilized, no third-party management, no replacement reserves, under market operating expenses, and such) will result in a different risk profile of the income stream and corresponding cap rate.
Many market participants do not include replacement reserves as an above-the-line (net income) expense when developing cash flow projections. Replacement reserves for future capital expenditures are market specific. Including or excluding replacement reserves will have an impact on the cap rate extracted from the sales transaction, but not the value of the property. Neither method is incorrect as long as the same method is applied to the property being valued and the sale comparable. If the sale comparable does not include replacement reserves in its pro forma projection, and the subject does include replacement reserves in its year one projection, the market extracted cap rate must be adjusted downward to reflect a riskier income profile of the sales transaction comp when compared to the asset being valued. If no adjustment to the cap rate is made, then the subject will be undervalued due to differing risk profiles. Properties that do not include replacement reserves have increased risk due to the lack of a sinking fund for future capital expenditures.
In other words, the NOI needs to be “clean”: One cannot compare an NOI with deducted reserves above the line with one deducted below the line.
Owner-Managed Properties
Another common misconception concerns third-party management fees. Small properties or ownership entities that have a built-in management company often do not include third-party management fees in their pro forma. Having a third-party management company manage an asset may reduce the operational risk of the property and can result in a lower risk profile of the future income stream. A lower risk profile results in a lower cap rate. Table 1 shows how excluding third-party management fees impact the year one return and risk profile.
As Table 1 reveals, a 7.5 percent cap rate is appropriate if the property pro forma includes expenses for third-party management fees. Based on the projected NOI and market extracted cap rate, a value of $1,666,667 is indicated. If the same property does not include management fees in the pro forma projection, the value of the property is unchanged, with the risk adjusted cap rate increasing to 8.1 percent.
This is why it is necessary for potential buyers to reconstruct NOI to include such items as property management. The increase in the cap rate is to account for increased risk due to the lack of professional third-party management. Additionally, real estate is considered to be a passive investment with the opportunity cost of the owner’s time requiring compensation through a management fee or higher rate of return.
Expense Comparison in Sale Comparables
Comparing the operating expenses used in a sale comparable to extract a cap rate is a good indicator if the cap rate is market driven. A sale comparable that is owner managed and does not include reserves will have below-market expenses on a per unit comparison (percentage of effective gross income, per square foot, per unit, and such). A comparison of the expenses from the sale comparables to industry standards used in the local market will allow the analyst to adjust the extracted cap rate accordingly and then apply the revised cap rate to the property being valued. If a data set of comparable sales indicates a wide range of cap rates, then it is likely that one or more of the sales is not based on market derived income and expenses.
Impact on Property Valuation
Table 2 shows how various income and expense projections can impact the extracted cap rate and the asset’s value indication. For purposes of this analysis, only one variable has been adjusted. In actuality, a sale comparable will often have multiple variables that need to be adjusted in order to accurately extract a cap rate.

The Table 2 example reports a market extracted cap rate that ranges from 5.70 percent, based on the asking price commonly quoted by brokers in third-party surveys for marketing purposes, to 6.48 percent, based on using year one projections. All of the extracted cap rates are correctly calculated. However, the difference in rates is attributed to varying risk profiles of the income stream. Based on the provided example, adjusting just one variable can result in a 13.68 percent difference in value. If additional variables are included, the spread between the cap rates can widen and further magnify the miscalculation.
While there is a simple formula for finding the cap rate, there is no standard method for cap rate extraction. Various markets and market participants apply different income and expenses projections when calculating NOI. However, a standard method for extracting a cap rate from market data is critical to properly value a property. Not all NOIs have the same risk profile. A property that includes third-party management and replacement reserves will have less net income, a lower risk profile due to adequate third-party management, and appropriate funds for future capital expenditures — and result in a lower cap rate. Regardless of the variables included or excluded in the cap rate extraction, if applied consistently to the property being valued, a reliable estimate of value will result.
The Cash Flow Analysis Worksheet used in CCIM classes shows reserves below the NOI line, so CCIMs need to pay careful attention to the components of NOI and make sure that the NOIs of comparable properties are calculated in a consistent manner. A thoughtful CCIM will re-construct NOI to be consistent and will know enough about cap rates in the marketplace and expense ratios, vacancy, and market rents to sense if adjustments are necessary to an advertised NOI.
By: Daniel Kann (Commercial Investment Real Estate)
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Office leasing could use a charge in smaller markets.
The recovery in the office market has been painfully slow in the majority of metros across the U.S. But a strengthening economy and more robust job growth could give the office sector a much needed charge in the year ahead.
Even the most seasoned brokers are growing tired of the pace of leasing activity where weak demand for space is the new market norm. Vacancies have been inching lower with a national average that improved to 16.7 percent in fourth quarter 2014, according to data from New York-based Reis Inc. Although that figure marks the lowest level since 3Q 2009, the year-over-year vacancy declined only 20 basis points.
Positive Signs
Nevertheless, there are some positive signs in both the broader economy and the office market that fundamentals are poised for a bigger leap forward this year. “I think you will see the market gain traction over the next couple of years,” says Ryan Severino, senior economist and director of research at Reis. Gross domestic product growth has been surging of late with an annualized 5 percent growth rate during the 3Q14, which is the highest rate since 2003. Last year also marked the biggest year of job growth in more than a decade. Job growth averaged 246,000 per month in 2014 compared with an average monthly gain of 194,000 in 2013, according to the Bureau of Labor Statistics.
The U.S. is finally getting to that stage where improvement in the labor market is going to start translating into greater demand for office space, Severino adds. To that point, nearly 11 million square feet of net absorption in 4Q14 was the highest level since the 3Q 2007, according to Reis. In addition, there is still very little office development by historical standards. That should mean great compression in vacancies and more acceleration in rent growth in 2015 and 2016, he says.

During the past seven years, many companies have made do with the space they had, perhaps extending in place in exchange for rent reductions or concessions. Other tenants were motivated to downsize or took advantage of competitive pricing to upgrade space for a comparable or reduced rent. “We have seen a lot of tenants move from one building to another to save 50 cents or a dollar per square foot,” says N. Justin Cazana, CCIM, a principal and broker at Cushman & Wakefield Cornerstone in Knoxville, Tenn.
To some extent, that is still occurring. But more companies also are shifting into expansion mode. In January, Cazana closed a lease deal for one Knoxville tenant that relocated to a newer 27,000-sf space in a class A building. The new space is about 60 percent larger than the firm’s previous location. “This was one of the first deals where a tenant is actually expanding in the market,” Cazana says. He is working with two other clients that are both looking for about 20,000 sf of new space, and Knoxville also is on the short list for two new call centers. “So the activity lately has really been exciting,” he says.
Uneven Recovery Persists
Although the forecast for more improvement ahead in 2015 is welcome news, the recovery is by no means equal in markets across the country. “We are at a point in the cycle now where the tide has raised all ships,” Severino says. The economic recovery has created stability and slight improvement in the office market. In 2014, only one out of the top 79 markets in the U.S. did not report positive effective rent growth, according to Reis.

However, there is a very large gap between the strong markets that have led the recovery and the rest of the metros that have lagged behind. Of the top 79 metros that Reis tracks, only 10 have seen effective rents grow above 3.5 percent in the past 12 months. Effective rent growth in the vast majority of markets is at or below inflation. The “haves” are clearly those markets that have been buoyed by tech and energy, such as San Francisco, San Jose, Calif., Houston, and Dallas, as well as major metros such as Boston and New York. San Diego, Orange County, Calif., Denver, and Seattle also are experiencing growth. “Outside of those market areas, it is still a very tepid recovery at this point,” Severino says.
Markets that rely on oil, gas, or technology have been outperforming the national average and that has certainly been the case in cities such as Tulsa, Okla. Although the local economy has a strong manufacturing base, the office market has been buoyed in recent years by the demand for space, particularly class A space, from oil and gas companies. “Over the past five years, there has been a flight to quality, because times were good,” says Patrick Coates, CCIM, managing broker and owner of Coates Commercial Properties in Tulsa.
The Tulsa market, which is home to nearly 23 million sf, has been very active recently. The class A office market currently has a vacancy rate of about 5 percent. In fact, the diminished supply of class A space has sparked new construction. Two multistory office buildings ranging in size between 60,000 and 80,000 sf were built in the past two years in the south Tulsa suburban market.
The city’s class B office space has a somewhat different story with large pockets of vacancy, especially among the older buildings in east Tulsa. The B-plus buildings are fairly full, while the B, B-minus, and C buildings are struggling with vacancies that might range from 18 to 30 percent, notes Coates. The class B buildings in downtown Tulsa are faring better due to some of the downtown improvements that have occurred. The area has seen investment in the form of converting older warehouse properties into museums, office, and retail space; a hotel; several new restaurants; and streetscape improvements. “Our downtown has really exploded over the last three years,” he says.
Tertiary Markets Still Struggle
Recovery is slower in many tertiary markets across the country. “There is a very low demand for office space in our market, and our vacancy rates are going up a little bit,” says Douglas M. Erickson, CCIM, a broker at Coldwell Banker Commercial SoundVest Properties in Rockland, Maine. Erickson covers the mid-coast area of Maine, which is home to about 114,000 people.

Maine overall is about 16 to 18 months behind the national trend in terms of economic recovery, Erickson says. Portland, Maine, seems to be a little bit busier, but growth has yet to trickle down to the towns situated in the mid-coast area, he says.
The mid-coast market is driven largely by its existing business base. “Right now, although we have a very good job market, we’re not finding new companies coming into the area for a number of reasons,” he says. Erickson predicts that it will take another year to 15 months to fill the excess supply of space due to the low demand.
Erickson adds that existing office tenants are still downsizing to some extent, particularly in the healthcare sector where some physicians and medical services are relocating to be closer to the main hospital in Portland. Companies across the board are being cautious about expansion and new growth, while some are also choosing to stay put in existing spaces and renegotiate lower rents. In two recent lease deals, it took Erickson nearly a year to find a tenant to occupy a 6,500-sf space and about five months to fill a 5,000-sf vacancy. “It is slowly coming, but it is going to take a little bit more time to catch up with the national trend,” he says.
Leasing Activity Returns
The gap between the “haves” and the “have nots” is expected to narrow in 2015 as the economic recovery continues to expand beyond energy and tech sectors. The drop in oil prices also will temper the rapid growth in some markets such as Dallas and Houston, at least in the short term.
Many metros have already started to see an uptick in leasing activity. During the latter half of 2014, tenants started making decisions again, says Terri Dean, CCIM, a broker/senior director and vice president of operations at Sperry Van Ness Avat Realty in Huntsville, Ala. Huntsville weathered the recession better than many metros, but the city was hit by government sequestration in 2013.
Huntsville has a strong concentration of government contractors related to NASA and the Redstone Arsenal, and sequestration created a lot of uncertainty in the market among civil companies. “They were cautious about renewing leases and renting spaces, because they weren’t sure if they were going to get any more contracts,” Dean says.
Although leasing activity is returning, tenants are still being cautious and making smart decisions about what they lease, she adds. Companies in general are just leasing the space they need and not accounting for future growth. “It is harder to lease the really big spaces, but it is moving again,” she adds. The office vacancy in Huntsville declined to 12.1 percent in 4Q14, which is down 70 basis points compared to a year ago.
Leasing in the Knoxville market started to pick up in 2013 and that activity ramped up over the last half of 2014. “People are a lot more confident in the Knoxville economy and in how the national economy is running. Businesses are taking advantage of what they see in stock markets and employment and trying to really position themselves for the next decade,” Cazana says. Some tenants are making a move because of market timing. They believe now may be, potentially, their last opportunity to take advantage of a soft market. Several submarkets in Knoxville are still overbuilt, which allows tenants to find an ideal location in a class A building with some incentives in place, he adds.
In Knoxville, landlords remain aggressive in both the CBD and major suburban submarkets. Tenants are looking for leases with turnkey construction and in many cases they are getting it, especially for spaces that are 15,000 sf or bigger, Cazana says. Although rent bumps will be significant over the long term, initial rents are still low and six months of free rent is not uncommon. “It is still a tenant-friendly market, but that is starting to change,” he says. “This absorption is starting to really get a lot of traction and it won’t be long before landlords will start getting a little more leverage in negotiations.”
Backfilling “B” Space
Some markets are seeing a “flight to quality” with tenants exhibiting a greater appetite for newer class A space, while older class B space remains a tough sell.
Case in point is Kansas City, Mo., where the class A-plus market has improved significantly. “Without much speculative development, there is a scarcity for premium space,” says Brent Roberts, CCIM, a first vice president at CBRE Group in Kansas City, Mo. “If you’re a 20,000-square-foot tenant you don’t have any choices in that product type right now.”
In contrast, the class B market has seen little movement in the vacancy rate or increase in lease rates, Roberts adds. “We have some larger chunks of B space in our market that have been vacant for many years,” he says. Even though that space may be significantly cheaper than doing a build-to-suit, some B owners just have a hard time attracting the right tenants, he adds.
Typically, class A space tends to lead the market recovery. But that is not necessarily true of the current cycle. “Even class A property has not had much of a recovery up until this point,” says Ryan Severino, senior economist and director of research at Reis Inc. That slow rebound in the class A market will likely mean an even longer road to recovery for older class B and class C properties that often struggle to compete with the features, infrastructure, and amenities of newer class A buildings.
According to Reis, class A vacancies have declined from a high of 16.8 percent in 2010 to hover at 15.4 percent for much of 2014. In contrast, class B/C vacancies have remained relatively flat for the last few years. At the beginning of fourth quarter 2014, class B/C vacancies were at 18.3 percent — a slight 20 basis point improvement over 2010.
By national standards, Huntsville, Ala., has a modest vacancy rate at 12.1 percent. However, that still translates to 2.3 million sf of empty space, which is a heavy load for the MSA of 450,000 people. Landlords, particularly among the B and C buildings, are reducing rents and offering incentives such as more tenant improvement dollars to attract tenants, notes Terri Dean, CCIM, a broker/senior director and vice president of operations at Sperry Van Ness Avat Realty in Huntsville, Ala.
Some owners are choosing alternative ways to recycle that empty space with conversions to other uses such as condos or apartments. For example, Huntsville-based Intergraph built a new 250,000-sf headquarters on its existing 300-acre campus that was completed last fall. The company has decided to redevelop much of the older space it vacated into a larger mixed-use project that will include office, retail, entertainment, and residential space. “They saw that with as much space as they had, there was no way they were going to be able to reuse that as office space,” says Dean.
By: Beth Mattson-Teig (Commercial Investment Real Estate)
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