Firms Can Paint Profitable Picture of Market if They Go by the Numbers
The average business owner could take a lesson from what Summit Commercial Properties did last year before embarking on a $400-million buying spree, Andy Florance believes.
Summit conducted an exhaustive statistical analysis of shopping center vacancy rates, rental rates and other market information, from which it concluded that grocery-anchored neighborhood shopping centers were a smart buy, even though most other investors were shying away from them at the time. The company has since closed 21 deals and is still buying the shopping centers, according to Summit President Jack Mahoney.
Florance is not affiliated with Summit, but he says most business owners should pay more attention to the kinds of numbers that the El Segundo company studied before making its investment decision.
As chief executive of CoStar, a Bethesda, Md.-based concern that collects vacancy rates and related statistics, Florance has a vested interest in making the numbers sound important, but his customers and other real estate professionals agree: These esoteric numbers, typically published in reports by major brokerage houses, are important to the bottom line.
Knowing whether vacancy rates and the supply of space is heading up or down and using that information to make a leasing decision, “can make the difference between whether a 10-person office with 2,000 square feet of space pays $40,000 a year or $80,000 a year in rent,” Florance said.
That’s just one implication of the significance of numbers like vacancy rates, absorption (the rate at which businesses are consuming new space), rental rates and the amount of new space scheduled to come onto the market. Other statistical measures are important, Florance said, but those numbers are the main indicators of what’s happening in any given market.
Cushman & Wakefield researcher Mike Rago points out that brokers, banks, developers, landlords, institutional owners, REITs, insurance concerns, finance companies, large corporations looking for space, individual investors and other clients need the numbers to help them make decisions about leasing, buying, selling and building new commercial space.
Rago said his brokerage spends $7 million a year on research into vacancy rates and related statistics, maintaining a staff of 100 researchers nationwide, including 15 in the Pacific Southwest market area of Southern California and Phoenix.
What makes the numbers important, Rago said, is what’s behind them: even more numbers, giving more detailed pictures of geographic sub-markets, trends within certain classes of buildings, where the biggest contiguous blocks of space are in all of the markets, and leasing activity at individual buildings.
The vacancy rates and related statistics have been around for a long time, but Florance said that commercial real estate brokerages and companies like CoStar have made a concerted effort to improve the accuracy of the numbers.
He said the industry has come to recognize the importance of the statistics in tracking the “mountain-and-valley cycle” of commercial real estate, in which rental rates can vary by 100% in as little as five years.
As Florance explained it, the cycle starts when vacancy rates rise, which drives down rental rates. As companies lease more space because it’s cheap, vacancy rates decrease and “developers start pumping out new buildings.” That creates an oversupply, and the whole cycle starts again.
“Developers live and die by these statistics,” Florance said. ‘They’re either doing back flips trying to keep the lenders from foreclosing on them when the vacancy rates are high or living high on the hog” when rates are low.
When vacancy rates are above 20%, he explained, rents fall and developers usually have trouble keeping their building leased, so they have a hard time paying their mortgages. When vacancy rates drop down to 5% or 6%, the building owners typically make hefty profits.
And the fortunes of developers, he added, help to determine rents that all businesses pay and whether space is available for expansion.
Those who track the numbers say the other statistics have become more reliable in recent years because of improvements in computer technology and efforts by commercial brokerages to use more standardized methods.
But the statistics reported by Grubb & Ellis Co., Cushman & Wakefield and CB Commercial, for example, rarely match precisely because they track office and industrial vacancies according to slightly different building sizes or definitions of geographic markets.
r Regardless of how the different brokerages and research services track the numbers, however, they generally agree on overall trends despite the small differences in their actual statistics.
The numbers sometimes figure in ways that the researchers would never have imagined, said Karen Petersen, an assistant vice president at Boston-based CB Commercial/Torto Wheaton Research.
For example, she said, vacancy rates and other statistics often make their way into court. “I have lawyers calling here all the time asking what market information was available five or six or 10 years ago because they are in litigation about a decision someone made that is now considered to have been a bad decision,” Petersen said.
Information about whether a market was soft or strong can be a factor in determining how much tenants who break leases have to reimburse landlords for lost rent, said real estate attorney Norman Levine, a partner with Greenberg Glusker Fields Claman & Machtinger in Century City. A former tenant being sued may have to provide less reimbursement if market information shows that demand for space was strong and that the landlord might easily have found a new tenant, Levine said.
“You can always tell what the economy is doing by what lawsuits are filed in the real estate context. You go from fighting over the profit on a new lease to suddenly trying to avoid a foreclosure because all of the rents have dropped and all of the tenants have gone broke,” Levine said.
Anyone who owns or occupies commercial real estate “really needs to have a feel for” the statistics to make wise decisions about whether to buy, sell, rent, renegotiate a lease, build an office tower or lend money for construction, said Robert Bach, national director of market analysis for Grubb & Ellis.
“If more people had paid attention to the numbers 10 years ago, we might have avoided the debacle in Southern California,” said Bach. “We all had the numbers, but not enough people listened to them.”
