As 2002 economic speculations abound and forecasters make predictions, Southeast Real Estate Business decided to conduct a survey of its own. We spoke with the following members of our editorial board to find out what they think the future will hold for commercial real estate in the Southeast: Carole Lewis Anderson, principal with Suburban Capital Markets, Inc.; O. Bowie Arnot, retail leasing consultant; Thomas Aschmeyer, senior vice president, regional manager with Column Financial, Inc.; Jeffrey Bayer, president of Bayer Properties, Inc.; James Carson, vice chairman of Carter & Associates; David Cohen, executive director of CIBC World Markets; Karen Burkhart Dick, CRE, executive vice president of Ackerman & Company; Gerald Divaris, chairman and chief executive officer of Divaris Real Estate, Inc.; Paul Domb, vice president, asset management with United Trust Fund; Bruce Ficke, CEO of Jones Lang LaSalle, Inc.'s account management group; Stephen Goldstein, senior executive vice president of Julien J. Studley, Inc.; Bernard Haddigan, senior vice president and managing director of Marcus & Millichap; Bo Jackson, executive vice president of Colonial Properties Trust; John Joyce, vice president, retail development with Aronov Realty Management; Allen Moczul, vice president of GMAC Commercial Mortgage; John Nelley Jr., managing director of Duke Realty Corporation's Nashville, Tennessee, operations; Timothy Prunka, executive director, Insignia/ESG's Florida and Caribbean operations; and Robert Saffran, vice president of The Goodman Company.

SREB: How is the slowdown in the economy affecting commercial real estate in the Southeast and/or the markets in which you work?

Anderson: The slowdown in the economy has dramatically affected commercial real estate in the Southeast (and elsewhere) because the slowdown was exacerbated by the terrorist attacks. The industries that have been most notably hurt are hotel and big box retail, among other single-tenant properties.

Hotels were already perceived to have higher than average -- and often higher than acceptable -- risk as collateral for the CMBS market. That was a result of a tremendous surge in development through the end of the decade, resulting in overbuilding in some markets coupled with a decline in patronage due to the high cost of gasoline and a decline in consumer confidence.

Dick: Job growth is the primary demand generator for office and industrial space. Southeastern (and national) markets are experiencing the recession with minimal job growth. A bright spot is that supply is not as far out of balance as the previous (early 1990s) down cycle.

Carson: With absorption being significantly down from previous years, there is an abundance of sublease space on the market. Additionally, with corporations not meeting earnings, many are taking steps to cut costs. This manifests itself in the form of cutting headcount, which in turn cuts space requirements.

Cohen: We have to take a more conservative approach to underwriting. With a recession, you have to be more cognizant of sales and the tenants that you are dealing with, whether it be in an office, industrial or retail property. And obviously, depending on what the effect is on those centers and the overall economy, it is going to reflect in multifamily housing in those particular markets as well.

Ficke: All transaction decisions were put on hold, whether buying new property or leasing new space. In the second half of 2001, operational and occupancy costs were at the forefront of everyone's mind.

Aschmeyer: The immediate impact has been felt on the sales side of the business due to the increase in the bid/ask spread on most commercial deals. However, high quality core retail and multifamily properties are attracting fast moving investment dollars. Many holders of real estate are reaping the windfall of all-time low rates.

Nelly: The slowdown has affected the office and industrial sectors of Nashville, Tennessee. Sublease space, particularly in the office market, is having a negative impact on office rental rates, both first and second generations. Rental rates in the office market are down and vacancy rates are up. The office market appears to be affected more than the industrial market due to the supply and amount of sublease space available.

Moczul: The slowdown in the national economy has impacted the Florida markets in which we work. Leasing activity in the office and retail sectors has slowed, and new construction, especially office, has tapered off considerably. The apartment markets have remained strong. The Florida economy is currently faring better than the national economy with unemployment rates running at least one full percentage point below the national level.

Bayer: Commitments being made by retailers have slowed down in the markets where we have a presence: Birmingham and Louisville. However, a slowdown from the runaway growth in some stores may not be bad; they need disciplined growth.

Divaris: There has definitely been a slowdown in the office sector in the markets that we represent [Washington, D.C., Virginia, South Carolina, North Carolina, Atlanta and Florida]. Many companies are being more cautious about expansion plans. The high-end retail sector, as it relates to malls, has definitely slowed down because consumers are being more cautious in spending. However, grocery-anchored centers have actually picked up in sales. Big box retailers like Wal-Mart, Kohl's and Target continue to expand and be very strong.

Saffran: The slowdown has certainly affected sales in most of our centers, which are primarily in Florida. As far as curtailing retailers' expansion plans, I get the sense that retailers are going to pick their spots more carefully than ever -- they are already beginning to withdraw from deals in marginal markets and seem to be focusing on A or B trade areas.

Prunka: The Miami/Dade office market, like the rest of the nation, continues to be negatively impacted from the crash of the technology industry, the general slowdown in the overall economy that occurred during the first half of 2001 and the terrorist attacks of September 11. The fear of future attacks has resulted in a dramatic decline in tourism, which is hurting the hotel and entertainment industries. This particularly impacts a world-famous destination like Miami.

Despite the current lackluster conditions, Miami enjoys a number of advantages over other cities that will help it recover quickly once business and consumer confidence is regained and the economy begins to improve. The city is very diversified and not tied to any one industry's success or failure.

Goldstein: Even in the face of a national economic slowdown, the Washington, D.C., office market remains the most stable market in the nation, with continued supply constraints and one of the lowest vacancy rates in the country. Tenant demand for Class A space remains strong particularly from growing law firms and the federal government while Class A rental rates appear to be stabilizing in the high $40s to $50 per square foot.

In Northern Virginia, the stability provided by the region's government contractors has helped minimize the real estate impact of the dot-com and telecom slowdowns of late 2000 and early 2001. For Maryland, biotechnology is increasingly becoming the greatest driver of the area's commercial real estate market.

Haddigan: In Atlanta, there was a significant slowdown in job growth in 2001; year-over-year job growth in September was negative. This is a sharp contrast from the previous 3 years, when the Atlanta region added a combined 212,000 new jobs.

The economic slowdown and events of September 11 have negatively affected Central Florida's local tourism industry, which will put a dent in the local economy. Local travel and tourism have started to pick up, however. In South Florida, the slowdown has affected both buyers and potential sellers. Many investors that own well-performing properties are not willing to sell right now. At the same time, buyers are reporting that financing is more difficult to come by than it was last year.

Domb: The business of sale-leasebacks has not experienced a slowdown -- we actually saw business pick up near the end of 2001. With the economy headed south prior to September 11 and the increased volatility as a result of September 11, there is little stability and even less yield within conventional investments/stocks and bonds. My view is that real estate appears more and more to be a safe haven.

Joyce: Office development had already started to slow noticeably after the tech stocks crashed and a lot of office space came back on the market largely as a function of dot-com companies scaling back or disappearing altogether. It may take another year or longer for that space to be absorbed and for demand to rise to a point that supports new office development.

SREB: Most cities are feeling the effects of this slowdown. Is this the case in your market(s)?

Carson: Absolutely. We're seeing this in Atlanta's vacancy and absorption rates in addition to the amount of sublease space available.

Bayer: There is more caution with decisions, and more pre-leasing is required. Checks and balances are needed.

Joyce: The lack of employment (or revenue) growth that is being experienced throughout the Southeast means companies do not need additional space to meet their current business plans. Those development programs that do continue to move forward will likely reflect very high pre-leasing commitments and be mostly single-tenant buildings with the tenant possessing an investment-grade credit standing.

Arnot: The demand for retail space in Baltimore has declined substantially. But, on the other hand, due to the Baltimore area's limited amount of suitably zoned space for large-scale retail development, the supply of retail space is still relatively tight when compared to other trade areas in the Southeast.

Jackson: Our office division has been actively developing in Atlanta and Orlando during the past 2 years. While two of our most recent suburban developments, Colonial Center Office Park in Atlanta and Colonial TownPark in Orlando, have experienced successful lease-up, our most recent experience has been a severe and quick reduction in demand.

Saffran: Luckily many areas of Florida (we are in South Florida and Jacksonville) are still growth markets, so retail is still being sought and developed, but the universe of expanding credit-worthy retailers is growing shorter all the time.

Prunka: Overall vacancy rates for the Miami/Dade office market over the course of 2001 rose 11.65 percent, up from 8.8 percent at year-end 2000. Available sublease space has also increased, and when the current 859,175 square feet of sublease space is factored into the current direct vacancy rate, the overall Miami/Dade County vacancy rate increases to 14.25 percent. However, even with the increasing vacancy rate and slowing absorption levels, rental rates have remained strong, even rising slightly to an average of $23.89 per square foot from year-end 2000's average of $23.50. Currently, more than 1.7 million square feet is under construction throughout the market. As space is added, absorption will continue to be sluggish but it is expected to pick up as the economy improves in mid-2002, as economists are currently predicting.

Haddigan: The Atlanta retail market will benefit from the slowdown in construction activity. The region's fiery growth during the late 1990s and early 2000 led developers to start several million square feet of new retail space, some of which is just now coming on-line. As of November, approximately 6 million square feet of retail space had entered the Atlanta market, less than the 7.8 million square feet delivered during the first three quarters of 2000. Although there has been a 23 percent reduction in the amount of new supply delivered to the market, vacancy in the region is up to 8.4 percent from 7.8 percent this time last year. Rent growth during the previous 12 months was flat.

SREB: What is the general feeling among tenants?

Dick: Many tenants are delaying decisions about their space needs at this time, particularly relocation or expansion plans. Many businesses are downsizing in the metro Atlanta area, as evidenced by a glut of sublease space. Subleases, or dispositions, represent a significant portion of the 2001 transaction volume within our brokerage firm.

Carson: Many tenants are using this as an opportunity to restructure their leases, and with the market conditions being such, tenants are able to get more concessions and improvement dollars out of their leases.

Prunka: Before September 11, the decision-making process for tenants was becoming protracted due to their unwillingness to make long-term commitments in an uncertain economic environment. After the attacks, tenants came to a virtual standstill in terms of making business decisions. Many decided to wait until there were some signs of improvement in the economy or the war effort before dealing with their real estate situations. Now, it appears that conditions are beginning to improve and companies are beginning to address issues needed to make long-delayed business decisions. There is still a good bit of hesitancy due to issues related to the shape and form of new security.

Goldstein: Available supply remains limited for the District's largest tenants, those that are anticipating additional growth in the next couple of years and have no room for expansion in their current locations. These larger tenants are planning far ahead of their expiration dates in order to secure the few, large contiguous blocks of space they will need. Many recent deals demonstrate a continued eastward movement for tenants, as well as an increasing interest in exploring less traditional addresses within the main business districts.

Ficke: We are seeing reduced capital budgets for tenant moves, changes and improvements. The approach now is to "use it as it is." This focus on cost has created an environment in which companies want to dispose of the underutilized space in their portfolios but they cannot sublease that space because everyone else is doing the same thing. Supply is outweighing demand.

Haddigan: Many national tenants have announced plans to reduce expansion this year, while other retailers are cutting their losses and closing under-performing stores. In addition, it is not uncommon to hear of a chain pulling out of a market or closing up shop completely.

In Central Florida, leasing agents in the region have reported that very little business was done from September 11 through mid-October. The attacks and the ensuing hit to the economy pushed many businesses into taking a "wait and see" approach with regard to expansion. However, leasing activity has been slowly returning to normal.

Some tenants in South Florida are downsizing and others are hesitant to expand right now due to uncertain national and local economic conditions. Financially sound retailers have continued with expansion plans to take advantage of South Florida's strong population growth projections.

SREB: What is the general feeling among building owners?

Dick: Building owners with vacant space are willing to reduce face rates to fill space. Conversely, owners with full buildings are offering "deals" to retain tenants. Most landlords in Atlanta are willing to discount face rents, but other concessions, like free rent and moving expenses, are nominal. Concessions will become more aggressive as the market weakens.

Carson: Most owners are optimistic; however, the market is clearly more concessionary than it was a year ago. They're competing with more sublease space and, as a result, they are lowering rent, offering greater tenant improvement dollars and offering more flexibility to tenants.

Haddigan: Owners are optimistic that job growth will rise and that the slowdown in new development will put upward pressure on absorption. However, the local and national economies are not forecast to rebound until the second half of this year. In the near term, most owners are realistic that lease-up periods will be longer than they have been in recent years.

SREB: Has your company had to make adjustments -- for instance, put plans for new developments on hold?

Jackson: Our go-forward strategy is to first secure significant pre-leasing in the 35 to 50 percent range. We are now practicing an even higher level of scrutiny regarding our prospects' underlying credit, company profile and respective industry outlook.

Nelly: Construction starts were down in 2001 in both industrial and office markets. New deliveries on the office side are up due to the pipeline that was in place before the slowdown. Our company has been decreasing new development due to slowing demand and will be cautious with new starts.

Joyce: Aronov Realty Management principally develops projects on behalf of food and drugstore retailers. The recession has not impacted the store expansion plans of these companies. Accordingly, we continue to actively pursue prospective sites for these merchants throughout the Southeast.

SREB: What is your 2002 outlook for the commercial real estate industry in the markets in which you work?

Ficke: The traditional real estate market lags the economy by 6 months. So at the start of 2002, it will be very difficult to achieve clients' 2002 goals for selling or leasing excess space. But as the economy rebounds so will the real estate industry. As we are seeing the beginning signs of recovery, the real estate industry can be expected to rebound by the fourth quarter with 2003 being a robust year as we all work to accommodate what will by then be pent-up client demands for space.

Divaris: Real estate has the unique advantage of being a long-term industry, and construction takes a long time to complete. So the industry has the benefit of time to adapt, and I honestly think that we'll be in good shape by the second quarter.

Domb: It may be the case of the glass being half empty or half full. There are opportunists who see value when times get tough. Conversely, there will be those who have to diversify and tighten their belts until the next cycle. I do not believe real estate will follow the cycle of the economy. Real estate will be viewed as one of the better investments for 2002.

Dick: The Atlanta market generally mirrors the national economy with a few exceptions: Atlanta tends to be more resilient due to a highly diversified economic base, and Atlanta's recovery is historically more robust because local job growth resumes more quickly.

The Atlanta real estate market should experience a lackluster performance in 2002 with market conditions improving in 2003 as the economy recovers and job growth increases. The market will be influenced by increased government spending on public improvements and defense contractors, and businesses requiring high capital costs that can take advantage of low interest rates. Atlanta's central location to serve the entire Southeast market is also advantageous for corporate and distribution consolidations.

Jackson: Office is a clear reflection of corporate optimism and capital outlay. Until corporate America produces two quarters of back-to-back positive earnings, we do not see a demand level warranting speculative office building development. That said, we understand and recognize that the over-exuberant economy was artificially driven by undercapitalized firms. That demand driver has been eliminated; therefore, our forecast shows a reduced demand through 2002 with a rebound in 2003.

Aschmeyer: Cheap money will provide a lot of cushion for deals that may have a short-term blip in cash flow while tenants work through their problems caused by our changed economy. Occupancy and rental rate issues will most likely come from shrinking demand more than increasing supply issues. New construction lending has certainly trailed off and should continue to remain slow due to the economy and the indigestion of bank mergers.

Carson: I think Atlanta will see an increase in activity and improved growth on the corporate side. The job growth will force the real estate market to rebound, and the stabilization of the economy will allow the market to pick up in mid- to late-2002.

Moczul: We are cautiously predicting a good year for the commercial real estate market in Florida for 2002. Except for pockets of excess office product in some markets, overbuilding is not prevalent. Interest rates are at historically low levels. We expect developers to replace short-term floating rate construction or interim debt with long-term fixed-rate debt. Lenders are reducing loan-to-value ratios on some product types such as office and retail. Hotel loans will be very difficult to secure.

Saffran: I think that retailers will be renovating more stores and paring down even more under-performing locations. They will only expand into proven markets, and in general will be opening less stores than originally projected, as you see by the daily announcements in trade journals and newspapers. As the list of expanding national retailers shrinks, the good, well-financed regional and local tenants will become more important to developers.

Prunka: While it was debatable if we were in a true recession before September 11, the attacks certainly pushed the national economy over the brink as they undoubtedly weakened consumer confidence. However, we are now seeing positive signs, the most important of which is the stock market returning to levels greater than those seen before September 11. This means investor confidence is returning, and because the economy is typically about 6 months behind the stock market, which bottomed out in late September, we should start seeing conditions begin to improve as early as this spring with meaningful recovery by the fourth quarter. Because the real estate markets around the country were not overbuilt as they were in the recession of the early 1990s, the rebound should be faster.

Cohen: CIBC's outlook is to increase originations and always look for good real estate finance transactions. There seems to be a general market study saying there might be a slowdown in CMBS originations. However, I think the originations will be steady for us because CIBC is a full-service lender, which differentiates us from several of our competitors because we are very active in construction, bridge and interim financing as well as fixed-rate. I think a lot depends also on how quickly the economy does recover and also what happens with the Treasury in terms of whether it rallies or trades off. There are so many variable factors that will ultimately determine the financing rate this year.

Haddigan: Fortunately, construction activity is declining. However, the dip is not expected to be deep enough to counteract the effects of an economic downturn. It is expected that vacancy will rise across the region through the first half of 2002, which will put downward pressure on rents. Losses incurred during the first half, however, will be recovered during the final six months of the year when the economy begins to improve.

Anderson: Some REITs, cognizant of appreciated values of properties in their portfolios, will continue to sell groups of properties. By using the provisions of Section 1031 of the Internal Revenue Service (IRS) Code, many are seeking to reposition their portfolios.

The outlook is very complicated because we are still fighting the specter of inflation, with underlying rates being lowered at an unprecedented rate. At the same time there are signs of deflation. Hotel values could simply be showing a cyclical decline, but if retail sales continue to drop and businesses continue to downsize, office occupancies will decline and we could experience some deflation.

The CMBS market was developed in the early 1990s. Many of the early loans (which had onerous prepayment penalties) will be coming due. This will contribute to permanent refinancing activity next year.

Joyce: I think there will be no appreciable growth in new office building development, but steady growth in industrial and retail space. The largest contributing factor that will influence the commercial real estate market will be the growth of jobs as the economy comes out of recession. Manufacturing output will increase (new industrial space); the tech industry will return (more office space); and new jobs will mean people will have money (and confidence) to purchase goods (new shopping centers).


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