End of Chapter 6 Questions and Answers 1. What were the primary reasons for over building in the late 1980’s and early 1990’s? Answer: Over supply in the mid 1980’s to mid 1990’s was induced by the additional factors of tax law changes and deregulation of savings associations. Accelerated depreciation rules permitted until the Tax Reform Act of 1986 increased the early year returns possible from tax-sheltered income. At the same time, deregulated federally chartered savings and loan associations were permitted for the first time in 1982 to lend on commercial real estate. Many inexperienced lenders provided such loans far too aggressively. The 1980’s excess supply was supply induced. By contrast the early 2000’s excess supply was demand induced as demand cut back with the economic slow down. 2. Define Class A, B and C space. Name three buildings that fit these definitions in your local market. Answer: Class A: Excellent location and accessibility; high quality structure and management; new or competitive with new buildings; minimum size 100,000 square feet if located in the Central Business District, CBD, or 50,000 square feet if suburban; rent rates in the upper 33% of the total office market range. Separate foyers and security. Example: The AON Building in Chicago Class B: Good location and access; structure showing very little obsolescence or deterioration; minimum size 50,000 square feet (CBD) or 25,000 square feet (Suburban); rent rates in the upper 60% of the market sector's range. Example: The Empire State Building in New York because of age may be a Class B but as it is so famous it may be considered an A. Class B Buildings tend to be buildings that were once built as Class A but are slightly dated. Class C: Buildings generally more than 15 years old, with rent rates in the lower 40% of the market sector's range, in less desirable areas with little if any common space. Example: Almost any older (20 years or more) suburban office building will be Class C. 3. What is the efficiency ratio? Why is it important? Answer: The percentage of total useable space to the total gross space in the building is called the efficiency ratio. It will be a percentage under 100%. The greater the efficiency ratio the higher will be the rental return per square foot of total building. 4. What are the leading causes of real estate cycles? Answer: The nature of real estate like: lumpy supply, long lead times, huge investment and long leases are the basic characteristics that cause cycles because of following reasons: Competition and need to anticipate the market. If a developer waited until there was sufficient demand for a new project they would never be able to beat out the competition who will take on the risk of anticipating future demand. There is no choice but to start a project before the demand has fully materialized. The time factor in developing a large durable asset like real estate. Larger projects like high rise office buildings take anywhere from two to five years to conceive, design, build and lease. With a minimum of two to three years before completion of a new idea, it is necessary to jump into the market before you will actually need the project. In the absence of collusion it is easy for more then one developer to try and fill the perceived market demand. When multiple projects come on line in the same period it is easy to have some extra vacant space waiting for the market to catch up. Extra space may be leased at more attractive rates in turn affecting the rents vacancy of lower quality buildings. Capital flows are not consistent. There are periods when lenders and equity investors are eager to move more money into the real estate market and other times when other opportunities seem more attractive. Lease terms create delays in rent adjustments and help to induce cycles 5. Why is it easy to make money at the bottom of a cycle but hard to do in practice? Answer: One never knows when it is the bottom of the cycle when the market is going down. It’s easy to say that those who invest at the bottom of a cycle will make more money. However in practice it takes real guts to start a project when you are near the bottom of the cycle, because you are not sure you are really at the bottom. Yet, for those who are lucky enough to jump into the market when few other firms are willing to commit and just before an upturn, most of the deals turn out much better then expected. 6. Why do developers keep building when we are at the top of a cycle? Answer: One ever knows exactly if you are at the top and by the time you find out you have committed to several projects already that are often better completed than left unfinished. When the market is going up everyone is optimistic and keeps on investing but stopping the capital and building flow is not that easy to do quickly. 7. What drives new office demand? How does the space required per person influence the demand and what is likely to happen over time to this figure? Answer: New employment of office workers is the prime driver of new office demand. The office space demand is estimated by multiplying the number of new office workers by the average space requirement per office worker. The higher the space requirement per worker more will be the total space requirement. With increasing trends of “office hotelling” and “telecommuting” the average space requirement per office worker is decreasing from over 200 square feet per worker in the early 1990s to about 175 or maybe less in the year 2002 for new tenants. 8. Why is it better to use specific SIC employment projections instead of gross employment in estimating future demand? Answer: Standard Industrial Classification (SIC) business analysis often reveals that certain businesses require more space per worker than other businesses. The reason such relationships are important is because not all businesses in the local area are growing at the same rate, nor does general employment growth tell us how much office space will be required except with a crude projection. Employment projection based on each SIC group, along with the percentage of employment in each sector requiring office space and the average amount of space per worker in each SIC group will result in a much more precise future demand estimate. 9. What share of office space demand is being captured by the CBD in most cities? Call some leasing agents and see if this holds true in your area? Answer: The CBD in most cities captures approximately 25% of office space demand. In some cities with few land constraints or regulatory boundaries much less and in constrained markets, (physically by lakes or mountains or by growth boundaries and regulation) central city demand has run higher. 10. The rent at which the project just induces new supply is known as the kink in the supply curve. Using the example of the 100,000 square foot office building what is the minimum rent at 94% occupancy that would induce new supply in this example? Where is the kink? Answer: We must see the text example to derive the costs of $16 million and the needed value of $18 million. The kink is at the rent level necessary to support $18 million in value. We need a cost of capital to derive the kink as well as occupancy. If the cost of capital from recent cap rates is 9% simple (covering both equity and debt) then we need net rents of: $18,000,000 times .09 = $1,620,000 and if we expect 94% occupancy divide this by .94 to get the gross rent required of $1,723,404 per year or $17.23 per square foot of building area. . 11. Which type of property tends to be more owner-occupied, manufacturing or warehouse space? Can you explain why manufacturing space tends to be owner occupied? Answer: Manufacturing property tends to be more owner-occupied because it is primarily a “built-to-suit” asset. Most manufacturing firms’ need highly customized space and arrange for this space to be custom built according to exacting standards. 12. You are opening a call center for the support of new software products delivered over the internet. You will need on line technicians and on line phone operators. Where might you open such a support facility? What factors would be important to you in deciding upon a location? Answer: The call location is an industry where people are the principal resource; hence availability of skilled manpower will be the deciding criteria for the location. The geographical location based on its closeness to customers is not important as the service is provided either digitally or through voice chat, which is carried to customers instantaneously through telecommunication facilities. Quality of life will be an important factor in deciding a location. The cost of operations like local income taxes, rent rates and salary rates will be other factors that need to be considered when deciding between the short listed locations. 13. What is an SPW and HTD warehouse? Why does it need more parking then other bulk warehouses? Answer: HTD: High throughput distribution center. These are the types of distribution warehouses that are facilitate small package handling primarily on e-commerce generated business. SPW are small package warehouses. SPW’s and HTD’s involve a fairly high ratio of labor input based on picking and packaging small packages, hence required more cars parking than the traditional bulk warehouse where a forklift picks up and ships an entire pallet of goods that might be sent off to a retail store. 14. Why are warehouses becoming obsolete faster then ever? What do you consider the economic life of an SPW or HTD? Answer: Continuously changing business models and technology demand different kind of services from warehouses and hence render them obsolete in much shorter time than their physical life. The most recent developments of warehouse formats is the SPW or HTD, which came in demand due to the B2B and B2C e-business models. The longevity of these new age warehouses will depend on the acceptance of these business models by increasing number of the population. Their reliance of increased manpower may render these warehouses obsolete in 10-15 years when technology will provide mechanized and computer driven systems to handle small packages efficiently. 15. Is your city a regional distribution center or merely a local market warehouse center? What criteria might you use to figure out if the local warehouses serve the larger region or just the local community? Answer: The average urban area has about 50 square feet of warehouse space per capita as of the year 2000. Much of this space is for local consumption and local business needs. If a local market, say Indianapolis has 85 square feet, then clearly they have 85/50 or 170% of the normal amount of space and we can conclude that the extra 70% must relate to being a true regional distribution center. Local city answers will vary and the data may not be that easy to collect. 16. What is a call center? Do you think we will see more call centers in the future or will people be able to work from home and simply be wired together? Answer: Call centers are offices located in a warehouse setting where rents are cheaper. The typical call center is filled with cubicles of workers that staff phone lines answering questions, taking orders, providing on line support. Call centers are becoming increasingly important in the new economy. Call centers require very secure computer systems with power redundancy and back up which makes it difficult for people to work from home and simply be wired together. Thus call centers are expected to increase in number in the future but we may also see more at home call center workers if the systems can be reliably connected. 17. Describe the factors that might influence a soft drink manufacturing plant location decision. Answer: A soft drink plant is a we ight gaining industry where the drink is bottled after adding water to the concentrate and hence needs to locate near the consumption centers. Factors influencing location decision would be: Proximity to large consumption centers (big city, town) Proximity to national highways (strategic intersections) Real estate costs Local taxes 18. What is an eco-industrial park? Are there any in your area? Do you think this is a trend that will increase in the future? Answer: Eco- industrial parks are those manufacturing locations symbiotic relationships are planned between various industries such that waste of one becomes raw material of other. They are still fairly new. Increased environmental awareness, negative public opinion and job creation benefits give a bright forecast for eco- industrial parks. 19. How is e-commerce influencing the distribution of services like music and books? What types of services and goods can you think of that are likely to be distributed electronically in the future? Answer: Due to e-commerce music and books are sold online with direct business to consumer delivery through efficient logistics. These are small products with a wide geographic market and hence it has influenced the way inventories are maintained and the mode of delivery. The handling of small packages make the warehouse labor intensive and the need of speedy delivery has caused more reliance on air transport. Music, books, computers and software will be sold online and customers will pay to download or ship them. Ticket services for air travel, reservations for cars and hotels and restaurants will increase, stocks trading and insurance are obvious services adaptable to on line ordering and sometimes delivery. It is unclear how deep the market will go for other consumer goods. Business to business commerce is the largest growth area for on line ordering of supplies, inventory and support. 20. What is a telcom hotel? Will demand for such properties continue to increase in the future? Answer: A telecom hotel is a large room filled with stacks of server computers each connected to power and communication wires through hubs with millions of electronic signals surging into and out of the building through conduit tubes in the ground. Old manufacturing buildings close into urban markets with strong floors often can be retrofit into telcom hotels. These rooms do not have human presence except for maintenance. As the demand of telecommunications and computing increases the demand for these telecom hotels will keep on increasing. However, as of late 2002 this market was overbuilt in most US markets.