Several of the most influential people in real estate offer their views on investment and capitalization strategies in real estate development and investment spanning back 20 years, comparing them to strategies implemented today, and forecasting what investment and capitalization strategies and opportunities may look like in the future based on emerging social, economic and industry trends.
Bill Collins started the discussion by going down memory lane starting with 1991 when the internet was introduced to 2016 when 10 year treasuries were down to 1.4% with negative 10 year bonds in Germany, Japan and other parts of Europe.
Don talked about DC in 1998, when the federal government felt like it was playing a smaller role in the economy, there was progress in technology and the real estate product seemed more progressive. Federal Realty did very well as a public REIT. The Don went on to say that the government has continued to act as a buffer in the DC economy.
Ray talked about Boston properties Properties and how in 1997 they decided to become a public REIT for diversity, liquidity, visibility and OP units. The capital markets were weak and real estate fundamentals were strong. When the company grew its portfolio the dynamics in the market were the exact opposite of what they are today. Cap rates were high in the 7.5% to 8% range and there was a lot of product available in the market. Today cap rates are in the 5 to 5.5% range and real estate fundamentals are declining. Boston properties was successfully expanding its portfolio in the late 1990’s but today the company is a net seller today in the DC market. Ten year treasuries were at 6.6% today they are at 2.2%.
Nick talked about the dawn of CMBS in 1995 and the conduit markets in 1997. Higher leverage non-recourse loans became the trend. Many as many Private Equity Funds that were raising their second funds[DPH1] ..
David talked about 1993 and the REO market and how Bruce and he started by first selling REO’s at Riggs Bank. In 1993, Bruce and David started buying REO and they went on to do JV transactions in 1998. David and his partners switched to a private equity fund model in 2010.
The panel discussed mixed-use development and whether there is overbuilding of mixed-use projects with the Wharf, NOMA, Ballpark, Bethesda Row, Pike and Rose, Boro, Reston Town Center and others in the DC metro area. Don talked about how real estate has changed physically with changes being shaped by consumer preferences. The cell phone has made the customer demand a level of service which was not present 5 years ago. All the cities including DC are urbanizing, consumers are demanding a high level of amenities and this is affecting retail. Goods and service providers are struggling with strategies to continue to be profitable. The best chance of survival for these retailers is to be near these urban centers in cities and surrounding areas. Mixed use is not the magic elixir, it works where there is are strong demographics with high levels of disposable income. It is more complicated, has more infrastructure costs, land assemblage costs and barriers to entry. There are specific markets where this works and all projects may not always default to a mixed use project. A number of town centers fail with changing consumer trends. Santana Row, a project developed by Federal Realty was priced during the boom and delivered during the bust resulting in a large gap in the projections and actual results.
Ray discussed the challenges of mixed use development and the fact that many large scale mixed-use development go through 2 or 3 cycles before they it can become successful. Significant investments have to be made upfront for infrastructure. The first three developers of Reston Town Center went bankrupt. Boston Properties acquired the property at 25 to 30 cents per dollar with the infrastructure already in place. When Reston Town Center delivered it was the only product of its kind. Boston Properties is planning to add additional 1.2 to 1.3MM sq ft of complimentary uses that will include office, multifamily, hotel, condos and retail at Reston Town Center. If 1.2MM sq ft of office was to be built it would take 10 to 12 years to be absorbed but a mixed-use complimentary use property can be developed at the same timeand absorbed over a much shorter time period. Reston Town Center today has the highest rents for suburban office, 98% retail occupancy with the highest apartment rents outside the beltway.
David is developing a large scale mixed-use project in Tysons and believes that Tysons today demands a mixed-use project of this size and scale. Meridian has 17 acres that will be developed with phase one already under construction. The fund has $300MM of equity in the $800MM development. Meridian has done 13 deals for $2.5B all near metro, urban locations, buying below replacement costs and at 1.5x to 2x multiples, value add returns with15% IRR
Nick discussed having worked on the Wharf financing and critical mass being created upfront was essential for the mixed-use project to be successful. In a mixed-use project, it is critical essential to build scale to show the commitment to the project by creating a sense of spaceplace.
The panel talked about Boston and how the Universities and Medical Technology is leading to a vibrant economy in the city. Young talent wants to stay in a place where there is critical mass and multiple employment opportunities for their skill set. DC has lagged as a result of having no tech university, not ano great significant venture capital market and the lack of ano home grown tech sector. The lack of regional corporation between the three jurisdictions also restricts growth. The catalyst in DC seems to be the growth of cyber security that may be defense related and will be enhanced by the growth in defense spending. Telecommuting and downsizing by companies has also resulted in creates negative net absorption in the market.
Factors that are contributing to growth in the DC economy include May MAE East and May MAE West, which are responsible for 70% of the internet traffic in the worldUS. Millennials are moving to DC and they make up one third of all home buyers; 50% of millennials bought homes in suburbs and 70% of all jobs are being created in the suburbs. DC still has 50,000 jobs created annually, 40% are office or high paying jobs. While NesteleNestle recently moved into Rosslyn, but this did not result in additional related company leasing activity. On the other hand, Amazon has leased 450,000sq ft in the Dulles corridor and it is anticipated that this will create demand for related office space in the submarket.
In DC today, we have 13 REITs, 7 or 8 private developers, 5 to 6 institutional players, and high barriers to entry. Excess supply is created as all of these developers have the capacity to create projects independently.
Government dysfunction is a concern. Sound political policies and tax reform would affect real estate significantly. DC has fallen from the number 2 city for investment to number 5 today.
Predictions by the panel for economic indicators:
10 year treasuries – 2 to 2.5% in the near term and moving to 3.5% with tax reform.
GDP growth – 2 to 3.5%
Cap Rates – will remain relatively flat for desirable properties but will remain move up for mediocre average properties. They Cap rates will move up significantly if interest rates go up.
Inflation – 2.5%
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Bill Collins, Vice Chairman, Cushman & Wakefield
Don Wood, President & CEO, Federal Realty Investment Trust
Ray Ritchey, Senior Executive Vice President, Boston Properties
Nick Seidenberg, Managing Director, Eastdil Secured
G. David Cheek, Co-Founder & President, The Meridian Group, LLC
Recap Written by Paul H. Deschamps and Sadhvi Subramanian