Commercial Real Estate Industry Outlook

A Roundtable Discussion Among Local Leaders

Utah Business Editors

January 20, 2012

Participants: Jeff Edwards, EDCUtah Cory Moore, Big-D Construction Vasilios Priskos, InterNet Properties Steve Peterson, Millrock Park Rick Woodbury, Woodbury Corporation Richard Bird, Marcus & Millichap Mike Falk, NAI Utah CRE Mike Drury, United Business Brokers Mark Bouchard, CB Richard Ellis Lee Peterson, Capstone Property Management Kevin Hart, Apartment Realty Advisors John Dahlstrom, Wasatch Property Management Jacob Boyer, The Boyer Company Greg Shields, Pentad Properties Gary Mangum, NAI Utah Fred Barth, Pentad Properties Don Whyte, Kennecott Land Bruce Bingham, Hamilton Partners Brandon Fugal, Coldwell Banker Commercial Andrew Bybee, Thanksgiving Development We’d like to give a special thank you to Jeff Edwards, president and CEO of the Economic Development Corporation of Utah, for moderating the discussion, and to Holland & Hart for hosting the event. Utah’s commercial real estate industry is experiencing a significant slowdown, like most industries across the state. Though bracing for the stalling to continue, the state’s commercial real estate leaders remain cautiously optimistic. Our group of experts discusses major developments still on track, financing issues that have stopped other developments and opportunities presented despite the economic storm. They agree that though the industry is experiencing its fair share of troubles, the government has positioned the state to weather the storm. How are today’s economic struggles impacting your companies and the industry in general? FALK: I think "uncertain" is a good word to describe today’s climate. Opportunity and activities are picking up, and at [NAI Utah Commercial Real Estate] we're rebuilding and expanding. BOYER: It’s a tough climate out there. [The Boyer Company] completed about five projects in 2009, and most of those were for the likes of the Veterans' Administration, the IRS, Myriad Genetics, so those have been great projects. It’s still a tough market, but I think we're seeing a little bit of heating up right now, hopefully. MANGUM: I've always been an internal optimist and I see the opportunities that we have in today's market. Having been in the business now for almost 30 years, I see great opportunity in a down market because I know that it's going to come back. Salt Lake and the Utah area have always been resilient. I see us rebounding probably a little bit quicker than in other areas across the nation. I'm very optimistic about what the future holds for Utah. S. PETERSON: [Millrock Development] didn’t have many transactions for the first nine months last year, but we've seen a flurry of activity in the last 90 days. We think the market's turned a little bit for the better. Three of our four buildings are 100 percent full. The last one is 60 percent full, and we expect it to be full by the end of the year. Going forward, we've created Millrock Capital as an opportunistic fund. We're looking for distressed assets in the commercial space. We anticipate seeing many opportunities in that area in the next 12 to 24 months with the mid-tier banks and community banks. As we bid on some FDIC assets and others, we have found that people are willing to pay too much for the assets for what we value them at. So there's a lot of money out there trying to be deployed, but we think as those funds are depleted over the course of the next six to 12 months, there will still be a huge amount of commercial real estate that banks will have on their books that are overvalued and will need to be disposed of. We don't think we'll be doing any development for the next three to five years. We think there's going to be too many opportunities to buy existing assets at a discount compared to what we can build them at. WHYTE: [Kennecott Land] develops the land that Kennecott Copper finishes with. The exciting thing that we see happening this year is that a lot of the vision of Daybreak is really going to start materializing in the sense that the University of Utah medical facility will be ready to open about the same time as the first tracks trains run out on the tracks that are currently under construction. In fact, they already exist in Daybreak, and that stretch will be used to test operating vehicles in the near future. We're also going to see completion of the eBay facility and our SoDa Row commercial operation filling up. We're cautiously optimistic, but I think we're also regionally postured to capitalize on some of these outside companies that are about to make decisions about moving into the state. DAHLSTROM: I'm with Wasatch Property Management and on our commercial side, we're just happy that our properties are stabilized right now because it has been slow the last 12 months. On our residential side, we're just completing the European collection of apartments here in Salt Lake, and we think that our development efforts will be focused in that area, along with transportation and transit-oriented-types of development. Then we'll broaden out back into a full development here in the next 18 to 24 months. BOUCHARD: We’re so guarded over the next 18 months about the market at a national level, but I think we're going to continue to see a wave of erosion on the housing side and foreclosures. From a banking and capital markets perspective, things are still going to be very difficult for most borrowers to get deals done, unless they're very well-capitalized and have a strong balance sheet. I think that the days of 2003 to 2007 are gone financially speaking. Only the best developers and best balance sheets are going to see projects get funded. On a local front, I do think that we have the ability to step out and lead the nation out of the recession. But frankly, until we start to see job creation, being optimistic is fool's gold. Both at the national and local level, until we start putting people back to work, it's going to be difficult for companies to expand. So we're just going to be trading deals between one landlord and the other or trading investments between one landlord and another until we can get some stability in the overall economy, which doesn't seem to show itself yet. I think we still have another 18 months in front of us and a lot of work to do. HART: I'm with Apartment Realty Advisors. We focus solely on multifamily assets, which tend to be an asset that's doing a little bit better in this environment. In 2009, we saw our volumes drop by almost half to $139 million. We’re hopeful that 2010 will be a little bit brighter. There are a lot of investors who are looking at properties and a lot of sellers who can't reconcile the pretty dramatic increase in cap rates and lower softer operations and so forth. It will be an interesting year to see what kind of properties trade and how the shadow markets either firm up or soften up, depending on the pending foreclosures and properties on the market. BIRD: I'm the principal broker and regional manager of Marcus & Millichap here in Salt Lake City. We only do investment sales; we don't do leasing or property management. I agree that apartments are the still sweetheart. We did 13 investment sales in apartments in the last 12 months, where a lot of the other projects have had a hard time in regards to office and retail. We've had a difficult time there in regards to the investment sale side of things. Still, there's a keen interest in retail, especially single-tenant retail. We have a huge out-of-state demand currently for Utah single-tenant retail, and I expect that to also be a strong point of Utah in addition to apartments. WOODBURY: Last year was pretty sluggish. [Woodbury Corporation] saw a drop in retail sales in our malls. And hotels were performing horribly. Small tenants, though, seem to be getting along. Overall, we think we are seeing some small signs of improvements, but most of the stuff is either government or religiously pushed—we’re still not seeing a huge amount of private investment. L. PETERSON: I’m with Capstone Property Management, a small commercial real estate management and leasing firm. We just handle third-party clients, largely in the Salt Lake County area. We’ve had an uphill battle in the last year, but we’re hopeful that we see signs of improvement. BYBEE: In 2009, [Thanksgiving Point] benefited on the development side from a pretty well low rate, and that helped us get through 2008 and 2009 because it allowed us to give some fair amount of concessions to stabilize things. Going forward, there’s a bit of interest rate risk, which makes it kind of hard to decide whether or not you're going to pull out ground, even if there is pre-leasing activity, and there has been a bit pre-leasing activity in north Utah County. We're also pretty bullish about all the transportation projects that are going on north of the county. SHIELDS: [Pentad Properties] is also a boutique retail and hospitality firm that’s been around since 1979. What we’ve seen is in the Wasatch Front area is that at least half the hotels are doing better than they were doing last year. Some are still doing a little bit less, but things have definitely turned. It's not looking like we’re going to see major growth, but we're also not seeing any kind of Armageddon. Most of the national prognosticators predict by 2013 hotel rates in America will be in real dollars, not compensating for inflation. And that’s a good precursor for other segments of the market because more business travel means more businesses expanding, which is good for all of us. BINGHAM: [Hamilton Partners] are developers primarily and somewhat investors in downtown office buildings and project and industrial activities south of the airport. Interestingly, we also are in pursuit of residential multifamily. I think we can say we're guardedly optimistic. The worst, I think, is over, but there's still some rough sledding ahead. The key to this on the investment/development side is going to be financing. Financing just has not freed up yet. Once we see financing starting to grow a little better, I think it will filter down to the rest of us. BARTH: What [Pentad Properties] is seeing on a retail side is some stabilizing in the market. We saw a lot of efforts last year by investors looking for distressed deals and hoping to find people willing to give their properties away. I think that there's some realism being brought back into the market. Landlords and tenants are finally understanding the economy now and are working together to keep projects leased. I think vacancies are down from last year slightly, and rents are just off slightly. So there's some stabilizing evidence in the market, and the very little development going on in the market has helped with absorption and it's also helped keep values in existing projects for owners. So we're seeing now that the opportunities are there, not so much in getting great discounts on properties, but being able to buy properties that have not been available before. We're finding with certain investors on land projects that they’re able to buy pads and projects that they were not able to get before. And that seems to be the opportunity. And those tenants that we represent that are doing well in this economy and are willing and wanting to expand, we're having to get creative and find private funding to help put those developments together. So there are some positive things going. It's just a different, creative way of doing business. FUGAL: [Coldwell Banker Commercial] has been fortunate to have both the blessing and challenge of representing some of the biggest projects along the Wasatch Front. I think some of the most encouraging things to date this year that we're observing include several corporate headquarter expansions in this market, which is unique to Salt Lake. We're seeing some positive signs, and we have some pretty exciting projects that are both preparing to come out of the ground in spite of the negative economy and also nearing completion. Are you finding adequate financing? WOODBURY: We have been able to finance a $10.5 million project, a $6 million project and two $3 million projects this year. However, they were existing projects that had some type of stabilized cash flow. And in almost all of those projects, we were able to take out money and we hope to take out money on the projects that aren’t closed yet. Now we're finding a huge resistance from lenders. There's a lot of people on existing projects who will say, "We will roll your loan" or "We'll take your loan for what the amount you have in it is, but regardless of your loan to value, we won't give you more money." Overall, financing a project is still really painful, but there is a little more relaxation there and there are a few banks that are starting to actually be a little bit aggressive. FALK: A lot of people are focused on financing for investors, and I think there's a great opportunity for the users of real estate. The SBA has 90 percent financing. And there’s government backing for many different projects. But, with all the money that the government is dumping in, inflation is just around the corner. And real estate is a great protection against inflation. PETERSON: We're finding new projects are buying existing projects at ever higher rates of private equity, loan to value or debt service coverage. And in terms of the lending institutions, we find that the larger banks have many terms available. In long-term financing, we're seeing a little bit of activity there with some of the larger banks. But the loan to values are much lower, possibly as aggressive as 70 percent loan to value. And the interest rates are about 6.5 percent. But a lot of the developers and borrowers need closer to 85 percent loan to value, so the only way to do that would be a short-term plan with one of the larger banks. And most of those larger banks, unless you have a relationship with them, aren't adding on new relationships. We have found if you have the right property and it's attractive, then there are a couple banks actually chasing after some of that business. EDWARDS: It's interesting, because if you ask the bankers, they all say, "Oh, we've got all this money to lend and we're ready to go." PETERSON: I agree. We’ve been in meetings where the CEO has stated that they’re lending. But right after the private banker has said, "I wish we could lend you some money, but we're not lending any money." DAHLSTROM: Last year we were talking about the second shoe dropping, after the residential debacle. We thought maybe we hadn't seen anything in commercial. I think what's been stated about the banks' willingness to lend to stable projects is good news. Even though that's not what we're used to, it’s relatively good news. MANGUM: I think one thing we're seeing differently now than we have in the past is that almost all the new money coming out is full recourse to the borrowers. It's tough to get a loan today where the property stands for itself as the collateral. So they're looking at strength of the borrower and holding them to it. EDWARDS: We've seen that repeatedly, too, especially in private deals where there's large stakeholders that are asking to be personally guaranteed on so many projects. And there are not many that are willing to go down that road. BOYER: Underwriting as it relates to the actual underlying tenant with these projects has become so much more critical. MANGUM: I've seen that in today's market as well. Even though it tends to be kind of a tenant-driven market today, a lot of landlords are being a lot more selective in the tenants that they're letting into their space that might have been really strong at one point in time, just because the fear of possible bankruptcy and the fact that they would tie up their property for some period of time in the event that did happen. So we're seeing landlords today that are requiring large security deposits and letters of credit. The strength and the size of the company would have been all a landlord needed to know before, but today they're looking with a lot more scrutiny. Discuss development in Salt Lake City. BINGHAM: The strength of Salt Lake City, as evidenced by City Creek, is not to be underestimated. The confidence that promotes throughout the nation is singular. Pound for pound, there isn't anywhere in America that's got the things going on that Salt Lake City has right now. Even in Las Vegas, which has as much money as anyone in the world can have in the free world, isn’t close to Salt Lake. They shut down their city center project because of lack of financing. We've got a major city project that's continuing. That just promotes confidence in investors and anyone from the outside, so we're very appreciative of that. Despite the positives, it’s still rough. I've been in this industry about 31 years, and the worst deals of my career happened just last month. I think it's just going to be hard for a little while longer. PRISKOS: We have national retail tenants looking for space on Main Street and not finding it. There's only one way that City Creek can expand into our city. It cannot expand to the north. To the west, we have the convention center, to the east we have the beautiful O.C. Tanner building. So there are very limited places to go. City Creek will really have quite an impact on our downtown going southbound down Main Street. I'm very optimistic with what's happening. And having an additional 700 units will help. I'm hoping those people that are buying them will actually live in them and not just be people that come to town twice a year. I'm encouraged with some of the buyers that have come out, and that will help immensely with small businesses opening. We had 30 new businesses last year open downtown. These aren't businesses that moved from elsewhere; these are brand-new, home-grown businesses. And I think that says a lot for downtown, and I think that trend is going to continue. DAHLSTROM: I think that with that move and with the vacancy that we have in classic space downtown, it's as low as it's been in the last 10 years. We really don't have an excess of inventory downtown in Salt Lake, which is a good thing. But it does provide opportunities for people who want to develop in the market. Also, we've seen a retail phenomenon. We do see retailers looking at Main Street, at State Street, at the areas south of City Creek. I think City Creek is going to be a huge boon to downtown. I think it's going to have a very positive impact on Main Street and to the south. So we've already seen some preliminary interest in our retail properties along Main Street. BOYER: We consider Gateway as part of downtown. I think particularly the residential that the [Church of Jesus Christ of Latter-day Saints] is working on is a great addition to our downtown. That will be great for all of us. We are concerned about making sure that the retail tenants that come into the downtown market are additive in nature and that we're not just doing a shift. There's a pretty aggressive leasing battle going on between the Gateway and City Creek Center, and that's the market working it’s appropriate to an extent. However, I think to the extent we can add new tenants to the downtown market, that's probably the best of all worlds for everybody. It brings more people downtown and it helps more folks. But I will say that there is a pretty aggressive strategy to target several of the Gateway tenants to come to the City Creek Center. Of course that's somewhat to be expected, but hopefully it’s not the sole strategy and there’s more of a combination of efforts. How has transit-oriented development impacted commercial and residential development? WHYTE: I think we still have a suburban development framework that's very low density in the Salt Lake area, which is not necessarily supportive of transit. I think we're going to see a transformation that will occur over the next 10 years where we start to see more development happening. Anecdotally, one of the developers who is doing transit-oriented development is finding that their customers say that their decision has been because of location, not necessarily transit. But I think we need to do a better job of taking care of and managing the opportunity that transit creates as developers in the area. We're trying to do that in Daybreak by combining both residential and commercial so that you have users that use transit both ways. And that's something that's not necessarily common in cities when transit arrives. Often instead, it's all directed toward getting people downtown. And a good example of that is that it is the University of Utah. The university makes very good use of transit and it's at one end of the line. In terms of residential, we need to do a better job of capitalizing on the opportunity that transit creates, and we're certainly going to be doing that in Daybreak. We're seeing national trends that suggest that there are buyers that are 30 years old today who would want a more urban experience. And recognizing that the urban experience doesn't need to necessarily be downtown, it could be located around the TRAX station. It's phenomenal to me that if you were to ask someone who graduated from the University, "How do you want to live," for years they would have talked about buying a single-family home and living in a suburban setting. Well, the answer today is not necessarily that. These are people that have grown up watching shows like “Friends” and they’ve seen interaction with others—now they really value that interaction. They like the idea of going to a mailbox and bumping into people. That's a different lifestyle than what we've historically catered to in this marketplace. So how we can accommodate that need at the same time in rental and in a fee-simple manner will be a real challenge for us. BINGHAM: Transit was fairly important in Goldman's decision to choose Salt Lake. Goldman has a parking requirement—they impact 11 people per thousand. It is just a density that is difficult to comprehend. So TRAX was very important because they'll never find the parking they need in any one building. DAHLSTROM: I think we're still at the front end of the learning curve on how transit can help our cities. But I think we've seen some positive movement in that direction. FUGAL: I don't think it's a coincidence that many of projects are located either adjacent to transit hubs or integrated as part of a massive transit-oriented development. Just look at Thanksgiving Park, which is right at the hub of the new commuter rail station that is nearing completion in north Utah County; the Geneva site, which will be the transit hub for the entire Utah County market; Station Park in Farmington that has the new Harmon's. I think those projects that we really are looking to lead this market and its expansion in the future have a transit component, and I don't think that's a coincidence. I think we're going to see that trend continue. Much like companies are moving toward more green and environmentally sustainable buildings, I think we're going to see more companies and developments gravitate toward transit-oriented areas. Outside of the Salt Lake Valley, what developments are going up? WOODBURY: We are involved a little bit in Logan. It's a small pond up there, but we have about six or seven poolings and an innovation center, and those buildings all have more tenants today than they did a year ago. And we are starting another building that will be essentially pre-leased. So I think Logan has largely escaped this whole thing. It's not vibrant, but it’s received a lot of positive national attention and it’s doing OK. WAHLSTROM: We've recently completed a hotel and conference center on the south end of Logan, and we have an office building that's full on the south end of the town as well. Those projects have been very successful for us. We've added something to market up there that hadn't existed in the past with the conference center. It's been booked and people love it, and we're thinking of adding on to what we've been doing up there. BOYER: The Business Depot Ogden (BDO) has been going great. It’s almost like there's a rainbow over BDO. In regards to the general commercial market with the junction, we just signed a 9,000-square-foot lease in our office building down there, but still are only 60 percent leased. It's a tough market. There are a lot of concessions that have to go into deals being made in terms of the office market. The retail market is pretty slow right now in downtown Ogden. We're chipping away at it, but it's slow. What about in Southern Utah? SHIELDS: Saint George seems to mirror the big city that's closest to it, which is Las Vegas, and I think it's obviously kind of in a different stratosphere than the rest of the state. I don't really know whether it's stabilizing or not, quite frankly; I just know that building is so expensive compared to other places in the rest of the state. It kind of looks like Las Vegas, but even Las Vegas is starting to flatten out a little bit. FALK: There’s a population increase of older people who want to be in Saint George, which is a great opportunity for investors with some patient capital, because the market will come back. And those who can come in and take advantage of some of those overbuilt situations will be successful. I think Saint George, in opposition to what's going on in Logan, is on the other end of the spectrum, but it presents some great opportunities for patient capital. Is apartment development still relatively strong? HART: 2007 was our lowest vacancy, just below 5 percent. Today it's at 8.7 percent. WOODBURY: And yet there's financing available. It seems to me that part of the problem when there’s overbuilding is that developers run to where there's money. There's no money in office developments and it's hard to get financing for retail, but because there's government financing for apartments, that’s where everyone is turning to. I’ve heard that there’s all sorts of new apartment projects being proposed or maybe even being built because there's government financing. And is the government making a mistake here? What I'm seeing is a vacancy rate that's increasing. It seems dangerous. MANGUM: I think if you look back through the last 30 years, you'll see that that's happened in almost every market in the country. We get overbuilt in the arenas where the money is available. HART: In 2009, we delivered about 1,500 total finished units to the market. In 2010, we're looking at 3,300. Now historically, projects under construction have delivered about 50 percent of what's under construction. So we may see 2,300 this year and maybe 1,000 or so next year. If we can stay on track with a modest economic recovery and if we can bring some employment back, I think the market will absorb it pretty well. Do you think we’ll experience a second wave of foreclosures in the commercial marketplace? MANGUM: Unless the banks start loosening up and refinancing deals, we're going to have a significant number of foreclosures that are going to happen. We see a lot of the big companies out there that have financed their growth and expansion through junk bonds, and I’ve heard about companies that are straddled with almost a trillion dollars worth of junk bond debt that's coming due in 2012. So we haven't even really started to see the tip of the iceberg with that—I think it's going to start over the next 12 to 24 months. And it's going to have to be addressed on both the national level and locally. SHIELDS: I think you're not going to see foreclosures on performing assets. PETERSON: I think the majority of the real estate out there is overvalued, and when the cap rates go up and the appraisals come back as far as additional capital, we're hearing that there's not enough strong sponsors to be able to pay down those. We're just at the tip of the iceberg, I believe. I’ve also heard that there’s going to be an additional round of bank foreclosures, much more substantial than what we've seen this last year due to the mid-sized banks and smaller banks having a lot of commercial real estate on their books and the sponsor's not having the financial wherewithal to be able to pay. Healthy properties will probably be OK, but there's a substantial amount that aren't stabilized. I believe there's the possibility of huge fallout within the next 12 to 24 months, but less so in Utah than nationally. BOUCHARD: I think we're in the throes of the most historic de-leveraging in this country in real estate that we've ever seen or ever will see in our lifetime. I think we're very insulated somewhat in Utah by how we do business and by the nature of the companies that we have here. I think that on the national level, we've only seen the tip of the iceberg. It is going to get significantly worse in the commercial markets in the coming two to three years. What are you looking forward to in the coming months? SHIELDS: I think there’s a lot of interest in Utah. We’ve got restaurant and retail clients who, when asked what their top cities are for an event or relocation, say, "We're going to do Miami, New York and Salt Lake." I think it's a credit to the fiscal conservatives in the state. I think it's a credit to a lot of people who develop projects and who didn't accept crazy financing. PRISKOS: I'm just happy with all the public works projects going on right now and expansions of I-15 going south, to the rail line going down south, the rail line to the airport, and the other rail lines that are under construction right now. Investment in infrastructure helps us all. And I'm especially pleased with what Salt Lake City is doing with the film and media center on Main Street, the performance center on Main Street. I think they're both economic generators, as are public works. MANGUM: On a positive note for our firm, we're looking right now for new corporate headquarters in the downtown area. We'd like to stay in the downtown region, but we're actively out looking. We expect to expand and to grow, but we have to have housing for our agents that will be able to accommodate our growth. Overall, we're bullish about what's coming down the pike. FUGAL: We're seeing a lot of corporate expansion. In first quarter alone, I've negotiated almost 300,000 square feet of leases, which is pretty positive. We have companies expanding that are getting a lot of national press like Fusion-io, which is a homegrown tech company. We've also gotten some good press out of Adobe's acquisition of Omniture. Provo Craft also just leased a new corporate headquarters space in the Salt Lake suburban market, which was a major expansion. Overall, there are a lot of reasons why fundamentally Utah is the best place to be doing business right now in the United States. And there are a number of companies that are taking advantage of our solid fundamentals in order to fuel their growth and expansion. MR. DRURY: Business valuations are still good. We're -- a lot of the businesses we work with -- we're working with anywhere from 120 to 150 businesses at any one time. And '09 was considered for -- everyone said, "Hey, if we can adjust our business to be profitable, cut expenses, in '09, we should be good," hoping that '10 would be in the same -- would be in a better position than what we're seeing across the board. Almost everybody has a brighter future in '10. We weren't expecting that until about third quarter, fourth quarter in '10. We're seeing backlogs, job schedules, a lot of work that was going to be done in '09 is now being captured in 2010. A tremendous amount of private equity groups that are interested in investing in Utah, from a lot of East Coast, West Coast -- all over the place are looking to invest in western U.S. deals, and primarily Utah, because we're all over the headlines about where we're stable and doing well.
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