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Do Dark Times Loom For Commercial Real Estate?

December 26, 2001

Article by Broderick Perkins

The tragic events of Sept. 11, 2001 dramatically shifted commercial real estate industry. Now, says one strategists, new business models are required to cope with the change.

Stan Ross, chairman of the board, at the University of Southern California's Lusk Center for Real Estate paints a darker Year 2002 picture than most for real estate owners, investors and property managers.

Unlike many who predict a return to economic growth by the second quarter, Ross says massive layoffs, high-profile bankruptcies and further drops in consumer spending will continue in 2002.

In November, the Federal Reserve Board's Beige Book reporting across all 12 districts said commercial leasing activity weakened further with increasing vacancy rates and softening rental rates. The one exception was the Philadelphia district, where rental rates remained relatively stable but also were expected to decline.

Commercial construction was flat in most districts, although Cleveland and Richmond reported a modest number of projects underway or planned for the near future, the Fed said.

Sept. 11th exacerbated economic woes and to cope real estate businesses will have to develop new business models to reflect corporate changes in planning for office, industrial and retail space that recognize the need for heightened security, the rise in insurance premiums and capital tightening.

"Companies are more concerned than ever with the safety, stability and continuity of their operations," says Ross.

"Businesses that choose to scatter their operations among multiple suburban settings will spend more on building security and less on amenities. Owners and property managers have to collaborate closely with tenants to assess risk exposure in new and existing buildings, and to decide who will absorb the costs of added security personnel and monitoring devices plus rising insurance premiums," he also said.

Building owners may be able to offset some of these new costs by trimming operating budgets and ultimately legislation will address insurance coverage for terrorist risks.

"Meanwhile financing for new development will be impacted as lenders wait to see when terrorism coverage will be available from insurers," Ross says.

Institutional players who understand the level of risk and retain confidence in real estate as a financial instrument likely won't overreact to any insurance shortage.

However, Ross predicts more alliances and partnerships among real estate services firms, security agencies, architects and engineers as they circle the wagons to join forces and develop security systems for new and existing structures.

Increased spending on the government level to secure public transportation and meeting places could cost building owners more in terms of property taxes or special assessments.

Ross hedges by saying his outlook for realty development and investment weighs heavily on whether the economy can pick up speed in the second half of the year, as many predict it will.

If not, investors will have an opportunity to acquiring properties at a discount from conservative sellers waiting for values to pick up.

If the economy is growing again by the second quarter, flat or slightly rising interest rates could curtail new projects, but boost both commercial and residential property values. Any signs of strength in the economy will also boost the demand for new office space.

Charging the real estate industry with the responsibility to get the economy rolling again, Ross says an industry not always so fast to adjust will have to be flexible.

"It is time to design the 'new world plan.' Firms have to be flexible with their business plans in the next year because the real estate industry has a responsibility to get the country back on track," he said.