Hessam Nadji: Real Estate & the Economy

Economic Bottom Reached; Recovery’s Shape Still Uncertain

Due to the depth of the recession and complexity of issues leading to the global financial crisis, government intervention and stimulus have escalated to unprecedented levels. In addition to the Fed’s interest-rate reduction to almost zero, the government’s unconventional initiatives have helped spark market activity. These include the doubling of the Fed’s balance sheet over the past two years as result of various rescue packages and liquidity injection and programs such as Cash for Clunkers and tax credit for first-time homebuyers, which targeted trouble spots in the economy. These programs have not compensated for the unprecedented drop in consumer and business demand; however, they have worked in averting the worst-case scenario for the U.S. economy and are providing a much-needed spark to reignite economic activity. Most importantly, the “fear” psychology of the past six months and extreme risk aversion by investors has clearly shifted in the right direction.

Recent Fed statements suggest interest rates will remain low for an extended period, though sentiment could reverse if inflation were to spike unexpectedly. A rapid tightening of monetary policy could derail the recovery and result in another deep contraction (W-shaped cycle), most similar to the twin recessions in the early 1980s. Given the amount of slack in the economy today, runaway-inflation fears appear overblown, for now. There are, however, other risks that could spawn a double-dip recession, including another financial sector shock, which could set a new negative feedback loop into play. Additional risks include a wave of commercial mortgage maturities over the next several years, the prospect of a supply-induced energy shock, or the possibility of higher taxes to offset the deep fiscal deficit. These risks are well recognized at this point, however, the slack in the economy should give the Fed plenty of room to avoid measures that risk a second recessionary dip.

The sudden and deep recession would lend some expectation of a V-shape recovery, which is also supported by historical post-recession periods, the majority of which saw first-year growth rates well above long-term averages. In fact, the tremendous volume of cash on the sidelines throughout the economy points to a potential of surge in investment and spending that would normally support a V-shaped recovery scenario. However, given the depth of consumer debt, high and lingering unemployment, and corporate focus on keeping a lid on costs for some time, the real estate industry is best served to prepare for a more gradual, U-shaped recovery starting in the latter part of 2009. Given the depth of the still-lingering credit market issues, a somewhat choppy pattern should also be expected before a sustainable cycle of growth takes hold.

Hessam Nadji is the managing director, research services at Marcus & Millichap Real Estate Investment Services. Contact him at hessam.nadji@marcusmillichap.com or (925) 953-1700.

Economic Update with Hessam Nadji

Economy: The Road Trip of 2009

This year I will remember as the year of our extended “Spring & Summer Tour” to visit with our most valuable clients, and to nurture future client prospects. So far, it has stretched from New York, Boston, Hartford and Washington DC to Los Angeles, San Francisco, Dallas, and with colleagues joining me in Chicago. In addition, I personally re-visited Abu Dhabi and Dubai and made a first visit to Oman and Kuwait.

The atmosphere at all the meetings was filled with a common thread of “braving the current storm”. The combined investment of these clients represented hundreds of billions of dollars worth of commercial real estate portfolios. Each agreed they have not experienced similar conditions since the early nineties. All had a clear focus of the challenge for their respective organization, but also articulated, with real ingenuity, how they remembered the transference to wealth making opportunities during the time period from 1995 to 1999. Nearly all of the discussions centered on the need for new sources of debt to replace the stagnant CMBS marketplace; the challenge of $1.4 trillion of debt maturities in the next five years, and how to be positioned to take advantage of the inevitable distressed assets that will work their way through the system.

As I reviewed the six month report from Real Capital Analytics it is a sobering realization that a 2009 home sale in Lake Forest, at $7.5 million, exceeds most commercial “investment sales” in our Metro.

There is an insatiable need, from your clients for a return to a real pricing model reflecting current valuations, and an exchange of market perspective.

As I reflect back on our “Tour” it reminded me of the classic United Airlines commercial, that many of you will remember, with the opening line “I heard from a good friend today”, as the executive hands out flight tickets to his employees.

Creative thought, working more closely than ever with friends and clients, will help to identify those inevitable opportunities.

Brasil - Solid BRICs

  

Sao Paulo - the largest and wealthiest city in Brasil, from the rooftop of Hotel Unique

Brasil is the first country of reference in the BRIC group of fast growing developing economies - together with Russia, China, and India, hold over twenty-five percent of the world's land and forty percent of the world's population. Recently, I was in a meeting with a global luxury retailer who referred to Brasil as unaffected by the global recession. Surely, no country is completely unaffected - though in relative terms, Brasil is experiencing a powerful convergence of forces - political stability, optimism, natural resources and enlightened corporate leadership that is unprecedented.

 

Carbon-neutral corporate headquarters of a 4 billion dollar beauty products company

Yesterday, a panel of Brasilian retail developers at the ICSC conference in Las Vegas presented their case for the great opportunities that abound in this country that is emerging from a long period of economic and political turmoil. Though there are effects of the global economy in play, there has been so much catching up to do that it is hard to feel the recession in play.  

 

Team exercise break at the manufacturing facility

From The Economist "In some ways Brazil is the steadiest of the BRICs. Unlike China and Russia it is a full-blooded democracy; unlike India it has no serious disputes with its neighbors. It is the only BRIC without a nuclear bomb." The Heritage Foundations's Economic Freedom Index, which measures factors such as protection of property rights and free trade, ranks Brazil ("moderately free") above the other BRICs ("mostly unfree").

 

bem estar bem -- the corporate mantra - "well being well"

I had the opportunity of working with some of these retail companies over the past year, and I met business leaders who spoke of their increased alignment with the liberal democratic leadership of the country. I developed the deepest respect for the level of commitment to enlightened and sustainable business practices that far exceed any I have experienced. 

 

indoor garden - employee lounge, and recycling

From saving rainforest species and indigenous cultures, to education networks, environmental leadership, and well-being of the customers and employees - we have much to learn from their leadership in a sustainable future.

Oscar Niemeyer's cultural center - modern master architect

The cultural richness is vibrant, creative, modern, yet deeply connected to nature - which I discovered in a great variety of built environments - from stores, workplaces, cultural centers, and hotels. Watch Brasil go forward, into the future. I think it will be fascinating, and illuminating for us all.

 

Sao Paulo - inside out, outside in

Snapshot from a Global Summit - Department Store Focus 2009 Moscow

 

 

 

 

Attending events over the last decade organized by the IGDS – Intercontinental Group of Department Stores, the Zurich based organization of more than 30 flagship stores worldwide, has always been an illuminating global snapshot of the pulse of leading retailers across the globe. I've met with them in Dusseldorf, Hong Kong, London, and Manila. The summit last week in Moscow at the historic GUM department store (shopping center) adjacent to Red Square included presentations by 14 leading CEOs. 

 

 

GUM Department Store, Moscow

 

Through the lens of the financial crisis and falling revenues, forward thinking leaders at the summit were focused on two important issues – engaging their customers emotionally, and the forces of online shopping. Understanding the impact of the digital universe on shopping behavior is considered critical for success and survival.

One of the most compelling talks was Andy Rubin, the CEO of Pentland Brands – UK, “Chief Emotional Officer”, who focused on the importance of truly engaging the consumer as the key to success. His take on major trends:

Economy – the downturn is not over, and may go on for years – plan for worse.

Polarization – growth in value and steady in luxury – most challenges are in the middle of the market.

Internet Wave 3 - the new internet is mobile, unlimited, free, and accessible from anywhere. New websites take advantage of this new kind of mobility and access, such as asos.com, for younger consumer, or net-a-porter.com that offers premium service, free delivery anywhere, free returns, etc.  (I would add sites like closetcouture.com and gilt.com as new models in fashion)

Sustainability – environmental responsibility and ethical sourcing are forces of change that will fundamentally change retailers on a global scale.

Mr. Rubin believes that brands love flagships. Why?

Flagships tell stories

If consumers identify with the story they identify with the product. Mr Rubin’s brand stories – Speedo on Michael Phelps winning 8 gold medals, Rene Lacoste creating the crocodile legend, Berghaus with Leo Houlding’s base jumping para-alpinist adventures.  His flagship stores allow him to fully tell the story through images, video, events, and activities.

 

 

Flagships are brand laboratories

Flagships are labs for new product development and testing, for bold cross-merchandising.  A flagship allows for consumer insight - regular thorough feedback from consumers is essential.  A flagship is a place to build customer service – qualified product experts and service are critical. It is particularly important in specialized gear stores – choosing a wrong sized suit in a Berghaus store can cost you a life. New brand propositions, brand educations, ethical messages, community connections, media venues, event stages, parties, celebrities – flagships are entertainment venues.

 

  

Other talks included Mr. Alberto Alessi, on Italian design factories and the market niche that they occupy – not quite mass production, very high quality design and manufacturing, producing ‘art multiples’, and the importance of poetic and spiritual value of things in addition to functional value (relative to the history of craft).

Mr. Allan Namchaisiri, President of ZEN lifestyle store in Thailand. ZEN is an 8 story hybrid containing a wide range - from very well organized and top of the line shopping experience, to cafes, restaurants, to spas, medical offices, childcare, clubs, movies. On Friday, while presenting at the conference, he was missing a DJ night that sold 4000 tickets to the club at the top of ZEN store… he believes that a successful store is a place where people come for everything - entertainment, socializing, medical treatment, good music, food, and, of course, shopping!

In general many presenters talked about the importance of entertainment and events (cultural, parties, special causes) taking place in the flagship stores as a way of emotionally engaging the consumers and building customer support. Flagship stores more and more become a stage for brand, showing a brand’s history and personality for customers to experience.

Mr. Michael Gould, CEO of Bloomingdales talked about identity as primary importance for their multiplying stores. The use of characteristic black trim and black & white floor patterns are critical to the identity of the stores in their various locations and sizes. It allows a distinctive connection between a much smaller downtown Soho store and a much larger 59^th street location. Bloomingdales also is making a shift toward more upscale merchandise.

Mr. Teymuraz Guguberidze, CEO of GUM thinks differently – he believes that mixing the upscale brands such as Chanel or Hermes with more budget brands such as Zara or Sasch is a key to the most important and biggest luxury – freedom - freedom of choice (today you may want to go to Chanel and tomorrow to Zara).

 

Given the shopping activity at GUM in the morning of a work day – he seems to have it right…

 

 

Summit report contributions by Anya Bokov, Director - Moscow Office, NBBJ 

Economy: When It's Time to Be Innovative, The Innovators Get Going!!!

Is the bottom of the market approaching? Is it already there, and we have been submerged for too long to avoid the effects of the storm, and for too long we have been drifting just off the bottom without realizing we could navigate to improved waters?

As the residential market preceded the commercial market decline, it now seems evident that the residential market, in all but the most depressed locations, is evidencing an uptick in the sales of existing homes. What does this mean? It is in my viewpoint the first and necessary step of infusing some money into the hands of the consumer; it also supports a belief that the economy is about to become active once again.

The innovators have already “got going”. These are the individuals that saw opportunity to position their companies in a downturn, to take advantage of a slow but gradual recovery, assisted by the effects of economic stimulus provided by our government. I do believe we are now exiting from that period of time that bred shock, dismay and inertia. Now we realize we are in a very different environment and we need to take actions that adapt to this new “norm” and these calculated strategies can actually realize growth and profits, as we emerge from recession.

In most instances, companies have curtailed unprofitable operations, streamlined their expense structure, and now are poised to be more nimble and innovative.

I read with interest today at how Playboy’s shares are trading for about 5% of their pricing of just over a decade ago. However, a close look at the company’s assets identifies that the Playboy mansion alone is probably worth 25 times its recorded book value. This offers great asset value to someone looking to buy this company or for the company to realize that gain.

In the 1990’s, during the last “great” recession, my company at the time was asked to address a relocation analysis for a transportation company, whose restricted means of access was affecting the company’s ability to operate, and more seriously was affecting company profitability. Through this single real estate exercise we noticed that many of their national locations had, over time, become inner-city rather than transportation friendly, and the conclusion resulted in their having the ability to sell the existing properties at way above book value, and relocate to less expensive, more operationally efficient new locations.

This is again a great time to evaluate your real estate, which is probably an undervalued asset on your balance sheet, affording you an opportunity to increase your earnings by the potential for sale, and secure the added benefit of increased earnings as profitability of operations recovers, and just like the transportation company, potentially create a more modern and efficient base of operations.

Economy: We Forgot About Risk...Again!

I recently attended a conference where a speaker offered his theory for the cause and severity of the current financial meltdown. He said, “The ‘fuel’ for the downturn was a huge savings glut that required investment and the "oxygen" was a systemic ignorance of risk.” This is not a new story, but the size, scope and number of businesses and asset classes impacted has been far greater than previous ones. Margins and returns were razor thin and 30-1 leverage was utilized by some for purchase of assets. Investment decisions were based on the notion that values had almost no prospect to fall and capital would flow freely for expected investment periods.

Will lessons be learned or will memories become short after the recovery, now forecast by many economists for the first half of 2010? Will more federal regulation and oversight be required to “assist” in minimizing future bubbles?

There will be a need for some additional action by regulatory authorities. As far as the financial markets generally, additional capital requirements and transparency for such financial instruments as credit default swaps should be considered. In the CMBS world, the selection of rating agencies for specific transactions by a government related entity, i.e. the SEC, may be necessary to help revive bond buyers' confidence.

Do the readers think this additional government oversight is needed? What are your suggestions?

India - Converging Forces in the Rising Consumer Marketplace

 

The growth and development of India’s emerging economy in recent years has been of great interest to me. India’s dynamic energy and vibrant culture, combined with the new economy, present a singular opportunity for retail development. Fashion week, Bollywood, and international designers are all converging in a market that, according to a joint study by ASSOCHAM and KPMG, expects US $25-30 Billion investment in modern retail formats over the next 4-5 years.

I am hearing sparks of optimism spreading across many markets over the past few weeks – from our clients and friends in New York, Paris, Moscow, Shanghai, Dubai, and more.  Many interesting personal connections to India have presented themselves recently, and I am increasingly intrigued by these opportunities. Having spent time in India, I find many compelling aspects to the culture, the people, and the opportunities ahead. 

First, a recent visit from Bangalore - both the Chairman of an enlightened development group as well as the CEO of an architecture firm that we are working with in India. The gift of a deeply thoughtful presentation on architecture, art, beauty, culture, memory and the merging of theory and practice. 

 

 

Then, a series of reports on business development and retail sector opportunities landed on my desktop. This was followed bya visit from a newly minted design intern from India, then London, now living in our neighborhood with a passion for retail design and seeking the beginnings of her career.  Then, a conversation with a friend on all the emerging opportunities - an international architect, originally from India whose career has been spent in the US focused on retail design.

With favorable demographics (two-thirds of India’s 1.1 billion population is under 35), nearing 50 cities with more than one  million residents, strong economic growth figures projected over the next 5 years, a growing middle class and ascendant wealthy households – the emergence of organized retail remains in its infancy.

 

Last year I attended a global gathering of retail industry leaders in London: imagine the UN of retail leaders.By far the most exciting, and dynamic talk we experienced was delivered by the Chairman of the major retailer in India. I’m looking forward to what happens next, and planning to be a part of it.

http://www.ibef.org/industry/retail.aspx

   

Chicago: Are We About to Emerge From The Doldrums?

Wikipedia explains "the doldrums" as a reference to being in a state of listlessness, despondency, inactivity, stagnation, or a slump. Sound familiar? It surely is representative of our economy and the last six months in Chicago Metro real estate.

I would hazard to guess that most of our existing, or potential new clients, have felt just like the sailors of old, stranded in a calm, waiting for the winds of change to rise once again, so they can begin to see the skies clear, and offer a glimpse of hope to guide them back on course.

There are signs of “clearing skies.” The Dow has grown from 6500 to surpass 8000 in just the last thirty days, usually a harbinger of a recovering economy. During that same time period, companies that have sound fundamentals, and a recent and proven track record have also shown comparable growth in their share value.

The developer, Hines Interests LP’s apparent decision to postpone a planned 50-story tower at the northeast corner of Lake and Canal, has created an opportunity for high-rise building owners to compete for that tower’s planned tenants, a scenario that would reduce the current inventory of available space in the Central Business District.

Michael Burgess, a British author, was once quoted as saying, “I have also believed in empowering the individual and believe there is a degree of inertia in big government that hampers the ability to respond to a rapidly evolving crisis.”

Those same empowered and insightful individuals will see this “clearing of the sky”, and recognize that the economic slowdown we are experiencing will constrain near term new development. As already planned current developments are delivered with significant pre-leasing commitments, we will see less inventory and opportunities for rental rates to continue to deteriorate. History, coming out of previous recessions, supports this theory.

Accordingly, this is a very good time to make those bold real estate decisions, be a decisive tenant, secure an array of current opportunities, and have one less decision to make as the economy continues to make its recovery and your business can take advantage of the “economic bounce” and get back on course, singly focused on growing your business, with that real estate decision behind you.