REAL ESTATE - Carlini's Comments

SHORING UP BUILDING VACANCIES

Filed Wednesday, October 10. 2007

What needs to be done in order to bolster downtown Chicago and suburban office building leases?

There is more economic fallout from the sub-prime mortgage market crash and other mortgage credit issues as real estate markets see an increase in vacancies at various office buildings. Crain’s Chicago Business recently ran an article that pointed out some of these trends in the suburban Chicago market.

Downtown Chicago is also feeling some vacancy problems as several high-profile buildings are being put onto the sales block in the East Loop area. Two towers within the Illinois Center are for sale as several large building owners in that area are thinking it’s a good time to sell.

Some tenants are migrating to newer buildings. What are their reasons? Are the amenities different? Are the older buildings technologically obsolete?

Discount Rates or Sell?

Vacancies are rising in older buildings and rents have to be discounted according to conventional wisdom in the industry. Too many real estate executives panic in a market like this. They go to the lowest common denominator: price per square foot.

This “strategy” (and I use the term loosely) has been used all over as everything else goes out the door. The way to try to entice a potential tenant is to drop from the market rate of $20 a square foot to $17.50 until Harry across the street drops his to $14.95. You then have to throw in six months of free rent on top of his new “market price”.

While that was the way to do it 30 years ago, times and strategies have changed. If they haven’t changed in a real estate organization, they better because just dropping the price isn’t going to work any more. The tenant market is much more sophisticated (especially for class “A” office space).

If someone is selling a building, the buyer better do much better due diligence. Most real estate investment trusts (REITs) don’t look at the technology supporting the building. The traditional approach for reviewing a building’s attributes has to be augmented. Otherwise, they will pay too much and this market will soon become a multimillion-dollar game of hot potato.

Building systems have to be reviewed. How “smart” the building is has to be asked and answered before any realistic price can be offered. A list of due diligence questions on technology is not what most REIT executives have in their back pockets.

Strategies, Buildings Have to Be Updated

If they are looking for blue-chip tenants, I can assure you the idea of selling space as a commodity is not going to work any more in attracting and maintaining a solid tenant mix. This is part of my white paper that will be published later in 2007 in the Intelligent Engineering Consortium’s annual review of communications:

“Intelligent Business Campuses: Keys to Future Economic Development” is a thought leadership paper that was finished after working on several planning issues with the DuPage National Technology Park. Key industry people were also interviewed from across the country along with several people from the Asian market.

The need to understand how to position real estate is a much more sophisticated approach than many traditional real estate and property managers have had to tackle. Corporate site selection committees are looking for different amenities than when a building may have been leased up five or 10 years ago.

This fact should be taken into consideration when making an offer to buy one of these buildings.

Define Class ‘A’ Buildings

The definition of a class “A” building has always been a building offering top-notch amenities and being in the right location. Many real estate executives have yet to figure out that the old real estate adage they still adhere to (“location, location, location”) has changed to “location, location, connectivity”.

While broadband connectivity was not on anyone’s criteria list 10 years ago, it is in the top three today. If you think you are in a class “A” building today, it better have broadband connectivity. That means fiber-optic connectivity and gigabit speeds. That doesn’t mean DSL or T-1 connectivity.

In doing research a while back while looking for class “A” buildings in DuPage County, there were more than 60 buildings that had vacancies. As soon as you put “broadband connectivity” in as a necessary amenity, that number dropped to six.

If a site selection committee was looking for corporate space, 90 percent of the properties that property management companies think are class “A” would be overlooked and therefore do not “rate” as a class “A” rating.

What did I just say? You read it right. Class “A” buildings are quietly being rated again just from a standpoint of connectivity. To some, that sounds too radical.

If property managers don’t have it as an amenity, they will be looking a long time for a replacement tenant. While they can discount and discount and perhaps they will snag someone, it won’t be a blue-chip tenant. That’s the reality of the market. This is the quiet revolution that has been happening.

Many in the real estate market have not seen it because they still have a lot of tenants on lease. As leases end and tenants turn over for whatever reason, you will see more class “A” buildings become less desirable. They won’t be able to attract and maintain the blue-chip tenants that are looking at connectivity as a required amenity.

It’s already happening. Unless developers and property management firms understand what needs to be offered to attract and maintain quality business tenants, they are losing tenants to new developments that may have been farsighted enough to add broadband connectivity. This also affects the regional viability to sustain economic development.

While traditional approaches are good in traditional markets, this issue is changing tradition. If you don’t think so, look at where corporate facilities are being located and relocated. The buildings and surrounding community offer broadband connectivity. This is true not only in the United States but in Asia as well.

Places like Far Glory Park in Taiwan and Cyberport in Hong Kong are examples of campuses offering high-speed connectivity as a common amenity for business tenants. As for organizations buying existing buildings, they better understand what they are buying. They don’t want to be playing hot potato in this market.

Carlinism: Intelligent buildings have been clustered together to create intelligent business campuses.