National Association of Real Estate Investment Managers (NAREIM): Uncertainty, Innovation, and The Future of Real Estate Investing
In times of disruptive change, new winners and new losers are often revealed. The question often becomes, how can I make sure I’m in the first category but not the second? Anticipating, understanding and responding to change was a passionate core of the discussion at NAREIM’s Asset Management & Acquisitions Winter Meeting in Dallas on January 15 and 16.
Evolving Strategies
Everything in commercial real estate seems to be changing—investor needs, employee values, capital markets expectations, and real estate market demands—and the pressure on leaders in this business is not letting up. The need to learn, evolve and connect with others in the business is greater than ever. In today’s real estate, leaders need to understand the emerging and evolving social, financial, geopolitical, and environmental trends are affecting risk and return. Changes in the past were often slow enough for forward-looking real estate investment managers (REIMs) to mitigate risks and seize opportunities. But to many, the pace of change is
allowing far less lead-time. So what can be done? How can someone be strong enough or smart enough to thrive in this environment? According to Charles Darwin “It is not the strongest of the species that survive, nor the most intelligent, but the most responsive to change,” Perhaps in today’s environment, as NAREIM President Gunnar Branson pointed out, “The ability to change
is more important than being the smartest or strongest. Perhaps we need to approach
our challenges in a different way than many did in the past.”
What are we facing, exactly?
Tenants may need less space. For example, law firm lease renewals are typically for
one-third less space than the leases they replace, due to electronic file storage, the
elimination of law libraries, and other efficiencies brought on by technology. Internet sales
are expanding faster than store sales, and as this trend continues, malls and shopping
centers may need to re-think their approach to space. Are we ready for higher density
of use and perhaps a lower gross demand for space on a per person basis?
People are acting different than before. Social and demographic shifts are in high gear.
Millennials, which make up the 18-to-34 age cohort that drives apartment and retail
markets, have tended to make different life choices than preceding generations—living in
cities, renting apartments and putting off marriage and children longer, driving less, and
acquiring fewer physical assets. Business people of all ages work outside the traditional
office more, and consumers are buying more and more online. All these fairly recent
shifts have a direct impact on office, retail, industrial and multifamily residential markets.
Are the assets in our portfolio flexible enough to allow for the changing uses of space?
Capital is changing. It’s not just about the defined benefit pension plans anymore. Global
capital, defined contribution plans, family offices and other investors of capital are looking
for different things from private real estate. Are we providing the right kinds of structures,
risks and returns for a changing client base?
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By: NAIREM Winter Edition (Acquisitions & Assets Management)
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Lease Language
The road to litigation is paved with creative clauses.
Although the basic ingredients for commercial leases are the same, they can vary widely in length and number of issues covered. While many aspects of landlord-tenant agreements are tried and true, what happens when an aggressive and creative landlord — or more likely the landlord’s attorney — inserts a provision into the lease that is unusual and then tries to enforce that provision through litigation? Often the result is expensive court battles over the enforceability and impact of the unusual lease provision.
Two examples of such provisions that have been recently litigated, the so-called “most favored nation” and “early out” clauses, provide guidance for commercial landlords that seek to insert similar provisions into their leases.
Two examples of such provisions that have been recently litigated, the so-called “most favored nation” and “early out” clauses, provide guidance for commercial landlords that seek to insert similar provisions into their leases.
Most Favored Nation
In the commercial lease context, the term most favored nation, which is borrowed from the international trade arena, refers to an arrangement where a lessee in a shared building, such as a strip mall, receives the benefit of any other tenant’s negotiations regarding matters such as costs per square foot for common area maintenance, taxes, insurance, or even rent.
These clauses are more often found in leases with national tenants that are in a strong bargaining position. That being said, landlords can also take advantage of these clauses under the right circumstances.
Over the last few years, national tenant Payless Shoesource has engaged a third-party consulting firm to review its leases and determine whether its landlords are complying with most favored nation clauses. This review has led to litigation over the meaning and enforceability of such clauses. Recently, Payless brought a lawsuit over this type of provision against Belmont Shopping Center LLC, located in Detroit, in Wayne County Circuit Court, Case No. 12-012419-CK.
Eventually, the landlord was put under immense pressure to resolve the matter, because a violation of the most favored nation provision triggered the tenant’s right to reimbursement of legal fees under the lease terms. As the case wore on, the settlement value of the case continued to rise until the landlord eventually had no choice but to settle.
The lesson that other landlords can take from this case is to be mindful that even a minor violation of this type of lease provision could have costly ramifications if pursued by an aggressive tenant, and landlords should be cognizant of the risks when agreeing to such provisions.
Early Out Clauses
Unlike most favored nation clauses, which are generally inserted in tenant-friendly leases, early out clauses favor the landlord and are more typically found in landlord-friendly leases.
Early out clauses have rarely been litigated and are usually only present in leases where the landlord is in a strong bargaining position. An early out clause essentially allows a landlord to terminate a lease before the expiration of its term as long as the landlord provides advanced notice and consideration in the form of a termination fee in exchange for the right to early termination. Thus, these provisions allow landlords to take advantage of rapidly changing market conditions by exercising the early out to create vacancies in hot markets, but give them the flexibility to keep existing tenants in down markets.
Although there is very little case law on such clauses, at least two courts have accepted and approved so-called early out clauses. For example, in re Ardolino, 298 B.R. 541, 544-45 (Bankr. W.D. PA. 2003), the court rejected the tenant’s argument to invalidate early out clause as the clause is consistent with other terms of lease and not otherwise ambiguous. Landlords may be able to rely upon this case to enforce not only early out clauses, but also to limit a tenant’s attack to any portion of a lease, especially if the tenant relies upon evidence of verbal promises or statements.
More recently, a Orion, Mich., landlord defended an attack to the validity of an early out clause in a summary proceedings case in the 52-3 (Rochester) District Court, in Baldwin Plaza, LLC v. Xuan Thi-My Duong, Case No. 13-C01635, aff’d on appeal, where the tenant argued that the clause was unconscionable, or simply unfair. The landlord ultimately prevailed, because the courts found that the tenant had ample opportunity to negotiate and/or reject the lease if it did not want to be bound by the early out provision. However, under Michigan law, a district court’s ruling is not binding on other courts, so this landlord-favoring ruling from the 52-3 District Court, even though upheld on appeal, does not have precedential effect. Binding or not, this decision should give some confidence to landlords that utilize and rely on early out clauses in the future.
Most favored nation and early out clauses are just a couple of examples of the wide variety of unusual commercial lease provisions. As the foregoing cases illustrate, the question of whether a court would uphold an unusual lease provision is only one consideration for creative landlords. There is also the matter of how costly it would be to enforce. Landlords should also consider how to be in the best position to enforce such clauses and whether the potential for costly litigation makes the clause more burdensome than its potential intended benefit. These benefits and risks should be weighed by the landlord with the advice of legal counsel. Be wary of simply regurgitating old leases that might have been successful under different circumstances.
– See more at: http://www.ccim.com/cire-magazine/articles/323385/2014/01/lease-language#sthash.DRtn4DMb.dpuf
By: Ian S. Bolton (Commerical Investment Real Estate)
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Obamacare Packing Medical Offices Spurs Deal Surge
Obamacare and an aging U.S. population are spurring purchases of medical office buildings, with investors sending prices to a record on bets that Americans’ demand for health services will increase.
Sales of properties leased by doctors and other health-care providers reached $6.67 billion in 2013, the second-highest total in 13 years of data-keeping by Real Capital Analytics Inc. Buyers including real estate investment trusts paid an average of $270 a square foot, up from $262 in 2012 and the most on record. The increase partly reflects deals for newer buildings with the latest technology, according to the research firm.
“It’s a really competitive space,” said Steve Sikes, manager of real assets at the Alaska Retirement Management Board, which is considering buying $150 million to $200 million of medical offices in what would be its first direct purchases of the properties. “Hopefully there’s enough of these out there for everyone.”
The buildings generate steady income from multiyear leases and offer higher investment returns than other types of commercial real estate. Buyers expect occupancies to climb along with the need for medical services as baby boomers age and more people get insurance under the Patient Protection and Affordable Care Act. More than 975,000 Americans signed up in December to buy plans under the law, which guarantees health coverage to all residents and penalizes those who aren’t insured.
Cash Flow
The properties include doctors’ offices, urgent-care clinics and diagnostic laboratories and imaging centers. Their stable cash flow makes the buildings particularly attractive to REITs, which are required under U.S. tax laws to pay out at least 90 percent of their income to shareholders, according to Dan Fasulo, managing director at New York-based Real Capital.
“You have built-in demand drivers vis a vis the demographic trends that fundamentally don’t exist in other real estate,” said Jeff Hanson, chairman and chief executive officer of Griffin-American Healthcare REIT II Inc.
The Irvine, California-based company, a nonlisted trust, purchased $816 million of medical offices in the two years through Jan. 2, making it the biggest buyer after publicly traded Ventas Inc., which acquired 72 such buildings in its April 2012 purchase of Cogdell Spencer Inc.
Investor interest in medical-office buildings is driving up values. Capitalization rates, a measure of returns that declines as purchase prices rise, reached a six-year low of 7.3 percent nationally in 2013, Real Capital data show. That’s still higher than the 6.4 percent average cap rate for general offices and 5.7 percent for apartments, according to the firm.
Hospital Landlords
More than 90 percent of about $1 trillion of health-care properties are still in the hands of hospitals and medical systems that may no longer want to be landlords, creating plenty of opportunities for institutional buyers, according to Hanson.
Among his company’s 2013 acquisitions were six buildings purchased from Middletown, New York-based Crystal Run Healthcare, a specialty physician practice group, for a combined $141 million. Crystal Run agreed to lease back the offices with 3 percent annual rent increases through 2033.
Griffin-American, owner of health-care real estate in 30 states and the U.K., buys stable, well-leased properties rather than buildings that need major renovations, Hanson said.
“We’re an income REIT,” he said. “Stability and growth of our dividend is paramount for our shareholders.”
High Occupancies
The company’s medical offices are 94 percent occupied and have a lease-renewal rate of almost 90 percent, according to Hanson. That compares with a nationwide 65 percent rate for industrial real estate and other types of offices, he said.
“You typically don’t lose health-care tenants,” he said.
That stability helps make medical offices appealing to the Alaska Retirement Board, which oversees about $25 billion of assets as manager of the state’s pension funds. The properties fit in with the system’s strategy of building a diverse real estate portfolio, which already includes corporate offices and apartments, Sikes said.
“The main appeal to us is the income component,” he said. Rising health-care demand “will improve the economics of providing those services and translate into a better real estate experience from a rent perspective and occupancy perspective.”
The shift to outpatient clinics instead of much-costlier hospitals for many health-care services also has boosted tenant demand for office space, said Todd Jensen, executive vice president and chief investment officer at New York-based American Realty Capital Healthcare Trust Inc.
Holdings Double
The nonlisted REIT’s medical office holdings almost doubled in the first nine months of 2013, according to a regulatory filing. As of Sept. 30, it invested $1.07 billion in the properties, up from $571 million at the end of 2012. More acquisitions are likely after a planned share listing this year, according to Jensen.
“Once you’re a publicly traded company, the Street wants to see you grow,” said Jensen, whose firm is managed by AR Capital LLC, the biggest fundraiser in the nontraded REIT business.
American Realty Capital Healthcare has $371.5 million of health-care property under contract, which will put its assets at $2 billion when the deals are completed, the company said today in a statement. Of that total, 44 percent will be medical office buildings.
Investors in public health-care REITs sold shares of the companies last year on concerns that rising interest rates would hurt the landlords’ ability to make money. Bloomberg’s index of 11 health-care trusts fell 11 percent, making them the worst-performing industry group in 2013. The broader REIT index slipped 1.4 percent.
More Vulnerable
Health-care landlords are more vulnerable to increases in borrowing costs because their buildings’ long-duration leases, which may range from three to more than 15 years, limit opportunities to raise rents. Income grows faster for owners of other property types that typically have shorter leasing periods and higher tenant turnover, according to Craig Guttenplan, a REIT analyst at CreditSights Inc. in London.
In times of strong economic growth, such as the years leading up to the 2008 financial crisis, health-care real estate wasn’t as popular as offices and retail properties, he said.
“It was not a sexy sector to invest in,” Guttenplan said. “As you see the economic recovery broaden and improve, you see some of the more stable property types get left behind.”
The large pool of properties to buy gives medical office investors ample opportunities to generate more income, according to Hanson of Griffin-American. A limited amount of construction should help landlords retain tenants and keep building occupancies high, he said.
Almost 15 million square feet (1.4 million square meters) of medical offices were completed in the past two years, compared with 41 million square feet in 2008 and 2009, according to Marcus & Millichap Real Estate Investment Services.
“You’ve got predictability and durability of income streams in medical office that you just don’t see in other real estate,” Hanson said. “You’ve got far lower risk in this sector.”
By: Brian Louis (Bloomberg Personal Finance)
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Latest Data on Retail Sales
In each Economic Update, the Research staff analyzes recently released economic indicators and addresses what these indicators mean for REALTORS® and their clients. Today’s update discusses the latest data on retail sales.
- Retail sales squeaked out a small gain in December, rising by only 0.2 percent from the prior month. Cold weather and more precipitation this past December compared to historical norms may have contributed to the sluggish sales. From one year ago, sales were up 4 percent.
- The national retail vacancy rate will not move down if sales rise at this slow pace. Rent growth, hence, will be difficult. NAR projects a retail vacancy rate of 10.1 percent in 2014, with retail space rents rising by only 2 percent.
- Recent softness in home sales is causing sales at furniture shops to decelerate. A similar slowdown is occurring at building and garden equipment stores.
- Employment at retail stores meanwhile has been increasing quite nicely, with a net gain of 381,000 in the past 12 months. But that growth is in jeopardy if retail sales do not accelerate higher.
- Because consumer spending comprises two-third of the economy, consumer spending growth (supported by job and income growth) is needed to further propel the economy.
- Spending at jewelry stores, interestingly, is rising at a double-digit pace. The record high stock market is likely causing the high net worth households to visit Tiffany’s on 5th Avenue, which then subsequently forces other high income people to spend conspicuously in order to keep up with the Jones. Though present, the show-off consumption is not that bad in the U.S. given many years of being a high income country. Pretty much everyone has a high-definition TV and a smartphone.
- Conspicuous spending is most visible today in Moscow. The newly rich need to show they are no longer pretending to get paid (and pretending to work) as occurred in former communist times. Though subway stations in Moscow contain artistic beauty, as if visiting a museum, the newly-rich refuses to take underground transport and are adamant to show off their latest German-made car even through they endure possibly the worst traffic jams in the world. Pedestrians beware: it is common for drivers to view the wide sidewalks as another lane.
By: Lawrence Yun (Economists’ Outlook)
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